The establishment of the IMA Global Emerging Market Bond sector in January 2014 highlights the growth in the asset class in recent years, as a growing number of funds with exposure to both local currency and dollar-denominated emerging market debt hit the shelves.
But the performance of the funds within the sector has struggled, with a one-year loss to May 28 2014 of 10.09 per cent, although for the year to date the sector average has been a more promising 4.46 per cent gain, according to data from FE Analytics.
This positive return coincides with the latest IMA figures showing the first net retail inflows into the sector in April 2014 of approximately £173m, having previously recorded net retail outflows for January, February and March of this year. This suggests a note of optimism is creeping back into the emerging market debt sector.
Giordano Lombardo, group chief investment officer at Pioneer Investments, notes that emerging market fixed income had held up relatively well until 2013, “when a ‘blind’ search for yield was replaced by a more cautious assessment of emerging market economic and institutional weaknesses”.
In his May Global CIO letter, however, Mr Lombardo dismisses the idea that the emerging markets are heading for a replay of the 1990s, a period marked by “high volatility and frustrating returns”.
He points out that most of the emerging market economies have progressed significantly in the past couple of decades, while the investor base is much more diverse.
“Another relevant difference compared to the 1990s is the emerging market debt structure. In the mid-1990s, a significant part of sovereign emerging market debt outstanding was denominated in dollars. This proved to be a significant cause of instability, as mismatches between revenues in local currencies and liabilities in dollars became unsustainable in times of crisis… Now, the situation appears materially different, as local currency sovereign debt accounts for about 80 per cent of total sovereign debt. In addition, the currency composition of external debt instruments is more local.”
Mr Lombardo explains: “In fixed income, we favour the corporate sector which is still offering an interesting risk premium. However, we are aware that the credit risk is affected by the country risk, as demonstrated by the underperformance of the ‘fragile five’ [Indonesia, South Africa, Brazil, Turkey and India] corporate bond index during the past 12 months versus the overall Corporate EM Bond index.”
Clearly, there is some way to go before emerging market debt starts topping the best-selling list for retail investors, given the continued economic uncertainty in the region, but for the moment at least it looks like there is some hope on the horizon. Whether the light at the end of the tunnel is a train or daylight will depend on the development of the macro environment.