Fund managers have rushed to allay fears of another emerging markets sell-off, as the dollar strengthens and the US Federal Reserve withdraws quantitative easing (QE).
The emerging market fixed income sector was hit hard in the spring of 2013 following fears that monetary support for the economy would be turned off, something that saw investors rush to exit perceived risky assets.
The average fund in the IMA Global Emerging Markets Bond sector fell more than 15 per cent between May 2013 and February 2014 and has yet to fully recover.
When the US finally stopped pumping money into its economy at the end of October, which coincided with the dollar appreciating against most major currencies, the spectre of that decline was once again raised.
But while emerging market debt has been volatile in recent months – rallying in August and early September only to rapidly give up those gains subsequently – a sell-off has yet to materialise in the same way it did in 2013.
Colm McDonagh, head of emerging market fixed income at Insight Investment, said the recent weakness in emerging market assets “echoes last summer’s ‘taper tantrum’”, a reference to markets reacting badly to the removal of support for the US economy.
In response to emerging market concerns, GLG Strategic Bond fund managers Jon Mawby and Andy Li have “substantially” reduced their exposure to emerging market debt during 2014, arguing that “the threat of tapering and rate hikes has increased the potential for interest rate volatility as absolute yields compress in the US”.
However, Mr McDonagh said the weakness should not lead investors to question the fundamental case for emerging market debt.
“The latest bout of market turbulence is necessary, and even welcomed, as it forces investors to differentiate between countries that are doing the right thing from those that are not,” he said.
Mr McDonagh said emerging economies were currently “grappling with the effects of a strengthening dollar, weaker economic news and a shift in inflation expectations”, adding there would be definite winners and losers in the sector.
One possible loser is local currency emerging market debt, which has so far significantly underperformed hard currency debt, which is denominated in dollars.
The First State emerging market debt team pointed out that while hard currency debt fell 0.6 per cent in the third quarter, local currency debt fell 5.7 per cent, mainly because the strength of the dollar led to a depreciation in emerging market currencies.
This has caused a significant disparity within the IMA Global Emerging Markets Debt sector. Funds focused on hard currency bonds dominate its performance chart, while local currency-focused funds languish in the bottom quarter.
Emerging market debt managers have said this weakness in local currencies could be set to continue.
JPMorgan Asset Management’s head of emerging markets debt, Pierre-Yves Bareau, said developed market monetary policy was likely to lead to “greater increases in global market volatility… notably in local market rates”.