EM bonds poised for sell-off when rates rise
Strategic bond managers have warned investors to avoid emerging market debt, which they fear could undergo another major sell-off as a rise in the US interest rate edges ever closer.
Increasingly strong data from the US, including a jobs report earlier this month that showed unemployment had fallen to 5.5 per cent in February, has fuelled expectations the US Federal Reserve (Fed) will increase its interest rate as soon as June.
Concerns are growing that any hawkish rhetoric from the central bank – indicating tighter monetary policy – could spur another sell-off in emerging market bonds similar to 2013.
The so-called ‘taper tantrum’ happened in May 2013 when the then Fed chairman Ben Bernanke flagged up the end of quantitative easing (QE), causing investors to flee fixed income, particularly in emerging markets.
In little more than a month following the announcement, the average fund in the Investment Association (IA) Global Bond sector collapsed by 6 per cent, while the average IA Global Emerging Market Bond portfolio nosedived by almost twice as much.
With the US preparing to tighten its monetary policy even further, Rathbone Strategic Bond fund manager Bryn Jones has already cut his own emerging market debt exposure “to the minimum”, as a result of the perceived headwinds the asset class faces.
“The returns on offer do not warrant the risks,” he said.
“The stronger US dollar is certainly a concern, especially when you take into account the fact that so many emerging markets borrow in dollar terms, which will make their debt more difficult to manage.”
Ariel Bezalel, manager of the Jupiter Strategic Bond fund, said he would be “worried about [emerging market debt] for the next six months” because the “stronger dollar could create problems for these countries”.
If the US raises its interest rate in June, the dollar is likely to keep strengthening against emerging market currencies, making it harder for emerging countries to pay off their dollar-denominated debt.
The rate increase would also improve yields in the developed market, making the higher yields on offer in emerging markets less attractive on a relative basis.
But in spite of Mr Bezalel’s concern, those running emerging market debt portfolios insist the sector is better placed to withstand any rate rise than during previous periods of US monetary tightening.
Kevin Daly, emerging market fixed income portfolio manager at Aberdeen Asset Management, thought the concern had been overdone and he was not anticipating a repeat of May 2013.
“We are not expecting a taper tantrum; for one, [Mr] Bernanke came out of the blue with that announcement,” he said.
“To say the asset class is going to suffer because of higher borrowing costs is misplaced.”
While he acknowledged higher rates would make debt obligations that bit more difficult for some developed nations, he highlighted the US was not going back to having interest rates at 5 per cent anytime soon.
Fidelity Emerging Market Debt fund manager Steve Ellis was also not being overly cautious in the run up to a potential shift in monetary policy.
“I do not think there will be much in terms of spread damage,” he said.
But he added the ongoing strength of the greenback would drive investors to hard-currency assets – which are denominated in dollars – over debt denominated in local currencies.
“Right now there is more risk premium embedded in hard currency debt – local currency less so,” he said.
“It needs a better risk/return ratio to what is being offered.”
