Emerging market fixed income: an attractive entry level after the correction
Emerging market debt has been the subject of much interest over the last few years, but recent volatility has created uncertainty about the asset class. We are convinced that besides offering an attractive return/risk ratio and the potential for high returns, current valuations constitute an attractive entry point.
Emerging market debt: considerable potential for growth
Emerging debt is no longer an asset class that simply provides diversification. Nor is it a niche asset class. Most institutional investors now view it as a core portfolio allocation, for both hard currency and local currency debt. Each component within emerging debt is now a broader asset class than US high-yield debt. Total outstanding issuance of emerging debt currently stands at more than USD 18 trillion. As the Chinese market opens up to non-resident investors, the potential for further growth seems considerable.
The recent correction is giving rise to opportunities
Emerging market debt is a more volatile market than the pure investment-grade debt market with annualised volatility of 7% to 10% over the past 15 years (depending on the type of emerging bonds), but with annualised returns of 7% to 8% in US dollar terms over the same period.
The period since this February has certainly been volatile. To put matters into perspective, in the wake of the election of President Trump, emerging debt temporarily became the pariah among asset classes, before rallying strongly in 2017 when geopolitical fears subsided. This rally ended rather abruptly in February 2018. In our view, this recent correction is healthy – valuations for emerging debt in hard currency and more selectively in local currency are once again attractive. Volatility will likely remain high in coming months, but this should lead to new opportunities.
No systemic crisis, but greater dispersion in engines of performance
Economic growth is somewhat weaker than forecast in emerging countries, but macroeconomic imbalances are concentrated in a limited number of countries (Turkey and Argentina). In our view, there is no systemic crisis, but a greater dispersion in the drivers of performance for the asset class. In the short term, there is uncertainty about emerging market currency valuations, but longer term, we believe these currencies are undervalued relative to the US dollar.
Facing strong growth headwinds, Beijing will likely maintain its policy easing bias for some time yet. We believe this scenario is positive for bonds in the short term, but weak GDP growth looks set to limit equity performance until signs of solid economic stabilisation or recovery emerge in China, as Chi Lo argues in this edition of The Intelligence Report.
Investors are increasingly considering environmental, social and governance factors alongside traditional financial risks. But many balk at using ESG criteria for emerging markets, worried this limits opportunities or potential returns, as Bryan Carter explains in this edition of The Intelligence Report.
To help brake the precipitous rise in greenhouse gas emissions that comes with rapid growth, electric vehicles could play an important role in emerging markets.
The Intelligence Report – Further to go
Making our range of investment products ESG-proof also means tackling asset classes and industries where data availability and transparency still have some headway to make. While challenges remain, for example in emerging markets, we can now rank debt issuers comprehensively on the basis of some 90 factors. This gives us a good view of whom to embrace and whom to avoid in our EMD portfolios, as Bryan Carter explains in the first article. Having a presence on the ground matters in this respect, including in China, where our senior economist Chi Lo keeps tabs on Beijing’s efforts to transform the economy while maintaining the momentum of growth. Read his latest analysis in our second article. Finally in this edition, an extensive write-up of the many efforts and initiatives – our own and those of the many multilateral organisations we belong to – en route to a sustainable finance system, all the while remembering that there is further to go before the world becomes a better place.