From Adviser Guide: Emerging market debt funds
Q: What are the pros and cons of emerging market debt?
A true stress test, solidifying the success of emerging market growth and reform momentum, was the financial crisis of the last decade.
Rob Drijkoningen, head of global emerging markets for ING Investment Management, said emerging markets became a driver of global growth, posting average GDP growth of 2.4 per cent in 2009, while developed economies (G7) experienced a contraction that averaged 3.4 per cent.
During the same period, Mr Drijkoningen said emerging economies continued to run current account surpluses, maintained sustainable debt levels and were able to undertake countercyclical fiscal and monetary policies to support growth.
The evolution of fiscal balances between emerging and G7 economies brings the points across, according to Mr Drijkoningen.
Post the Asian and the Russian crisis in the 1990s, he said emerging fiscal balances ran higher than G7 ones, but since 2002 they have moved structurally lower in absolute and relative terms.
In 2009, Mr Drijkoningen said emerging countries ran at half G7 levels and the gap between the two is expected to persist over the next three to five years given the dramatic fiscal adjustment required in the developed world.
From 2002 onwards, he said outstanding emerging market debt stock has grown exponentially.
On the supply side, Mr Drijkoningen said this phenomenon was supported by significant improvements in emerging countries’ fundamentals and contributions to global output and growth, causing the outstanding debt to rise in absolute terms.
On the demand side, he said the general search for yield resulted in strategic allocations from foreign investors.
Also, he said domestic institutional investors increased their demand for a broader range of investment opportunities in their domestic currencies.
On average, Mr Drijkoningen said total emerging market debt stock has grown by about 16 per cent a year since 2002.
Growth rates of external debt were constant around 11 per cent, he added, while domestic debt has grown at a faster pace of 17.4 per cent since 2002.
Brett Diment, head of emerging markets on the fixed income team at Aberdeen Asset Management, said the pros of emerging market debt are:
1) Global growth indicators better than expected, supportive for EMD.
2) Emerging markets offers dynamic opportunities with growth rates of more than 4 per cent. The IMF has predicted that by 2013 emerging economies will account for more than half of the world GDP.
3) Hard currency spreads are falling but remain attractive given lower default risk.
4) Emerging market sovereign debt has shown a steady improvement in credit quality with a growing proportion of bonds in the investment grade range.
5) Emerging market currency and corporates are poised to outperform as risk appetite improves.
6) Local currency debt is attractive as there is potential return from higher yields than in the case of dollar-denominated debt. Currency appreciation is also highly favourable.