Emerging market debt returns ‘force rethink’
Fixed income managers ‘will have to revisit portfolios’ after high emerging market gains.
Emerging market bonds have generated 4-5 percentage points more growth a year than US or global debt since 2000, according to research by HSBC Global Asset Management.
Peter Marber, chief business strategist for emerging market debt and currencies at the group, said the research highlighted the benefits of rethinking traditional portfolios, which typically have a very high weighting to the developed world, in light of recent returns for fixed income.
“The mid-2012 global interest rate environment may be the most perplexing in recent times,” he said.
“The combined effects of the economic slowdown, eurozone debt crisis, loose monetary policy, and a healthy dose of fear has led to a collapse in government bond yields.
“This is a quandary for investors, particularly large liability managers such as pension funds and insurance companies, and many are asking if diversifying into emerging market debt can be part of the solution.”
Since the creation of the eurozone, Mr Marber said bond indices had become far less diversified in terms of their exposures to individual countries. Most global portfolios hold 90 per cent of their investments in assets denominated in dollars, euros and yen, with 5 per cent in sterling and little in emerging markets.
“Roughly 90 per cent of this index has experienced credit downgrades in recent years, whereas emerging markets continue to grow faster than advanced economies and, more importantly, have less debt relative to GDP,” he added.
While investors tend to assume equities are the way to reap returns in emerging markets, Mr Marber sees debt and currency as more important.
Correlations between the growth of individual countries and the performance of their stockmarkets is low. India and China grew fastest from 2003 to 2009, but their respective markets were only average among the emerging world.
By contrast, Mr Marber said the strength of emerging economies should mean their debt will be revalued higher still, with less dependence on borrowings from abroad.
The number of emerging markets with investment grade ratings has risen substantially, for instance, from less than 10 in 1985 to more than 40 today.
“Emerging market hard currency reserves have swollen from $500bn (£308bn) in late 1996 to more than $8trn in mid-2012,” he said.
“This combination of rising productivity, increased reserves, and greater economic momentum should also be captured in lower emerging market credit risk premia. Today overall country leverage is comparatively light at half of the eurozone and US levels, which is why emerging market sovereigns have experienced roughly a five to one credit upgrade-to-downgrade trend for the few years.
“With the exception of another global meltdown, we believe emerging markets debt has the potential to continue to outperform advanced country paper in most economic scenarios.”