While the emerging market (EM) growth story has been around for some time now, investors are perhaps less inclined to dip their investing toes into emerging market debt.
Concerns around the creditworthiness of some countries in the region may have put people off in the past, but there is recognition that this asset class is becoming more mainstream.
An emerging market debt white paper, published by ING Investment Management, identifies several ways in which policymakers have built up the credibility of emerging countries. These include the reduction in external debt levels, the liberalisation of fixed exchange rate regimes and the adoption of inflation targeting.
It also cites the free flow of capital, the development of domestic capital markets and the removal of barriers to trade.
ING suggests the financial crisis of 2008 was a “true stress test” for the region, with emerging market economies posting average growth of 2.8 per cent in 2009, while the developed economies of the G7 saw a contraction that averaged 4 per cent of GDP.
Rob Marshall-Lee, manager of the Newton Global Emerging Markets fund, says: “One of the greatest areas of potential for emerging markets over developed markets in the longer term is the scope for superior economic growth rates, generated as a function of increasing employment rates within a more rapidly expanding workforce. This goes hand in hand with increased aggregate demand.”
Roy Scheepe, senior client portfolio manager of emerging market debt at ING Investment Management, notes the interest and the level of investment into EM debt has grown in line with the growth of the economies.
“Investors clearly now distinguish within the asset class between hard currency and local currency, sovereign and corporate, short-term and long-term maturity,” he says. “As the size, liquidity and diversity of the overall asset class is increasing, which is a sign of maturity, one can perhaps already say that EM debt is becoming a mainstream asset class, especially for fixed income investors.”
Fixed income as an asset class generally performed well last year, delivering impressive returns in spite of a low global growth environment. Claudia Calich, manager of the M&G Emerging Markets Bond fund, refers to 2014 as an “eventful year” for emerging bond markets. She points to the strong performance up until September, when markets corrected significantly as the crisis in Russia deteriorated and the price of oil plummeted.
Ms Calich says: “Overall, the emerging market debt asset class still posted a positive total return in the year, in spite of the declines recorded in local currency markets. Important factors in generating good performance in 2014 were making the right asset allocation calls and avoiding a few deteriorating credits.
“In the final quarter of the year, investor sentiment towards emerging bond markets became increasingly driven by the key theme of sharply lower oil and other commodity prices.”
So where does that leave emerging market debt in 2015? The list of potential headwinds and tailwinds include commodity prices remaining at a low compared with a year ago, as well as the ongoing geopolitical risk in Russia and Ukraine.
There is also the rising interest rate story, which may yet play out this year as markets wait for the US Federal Reserve’s Janet Yellen to make the first call to hike the rate.
Ms Calich points out: “In Indonesia it was encouraging that the government took advantage of the oil price fall to reduce the subsidies it was paying for fuel usage in the domestic economy, which has positive implications for its budget deficit.
“The prospect of a rising US interest rate also presents a headwind for emerging bond markets, although my expectation is that some regions, such as Asia, should prove less sensitive to outflows to the US than other main regions, such as Latin America.”
David Oliphant, head of investment-grade credit at Threadneedle Investments, does not expect any meaningful returns in government bonds in 2015, but he predicts that spreads will tighten in investment grade.
He notes: “In the inflationary recovery scenario, total returns in investment grade would be affected by rising government bond yields due to the longer duration nature of this asset class. We would expect to see high-yield and emerging market debt deliver better returns in the slow growth and inflationary recovery scenarios.”
Ellie Duncan is deputy features editor at Investment Adviser
EXPERT VIEW
Roy Scheepe, senior client portfolio manager at ING Investment Management, gives his view on investors’ perceptions of emerging market debt as an asset class:
“It is a mixed picture. Investors in general like the yield level of emerging market debt bonds and acknowledge the good historic investment [risk-adjusted] returns. Valuation versus other fixed income asset classes is deemed attractive as the search-for-yield theme is still an important driving force.
“On the other hand, they are also somewhat fearful about the volatility of the asset class, especially with regard to emerging market currencies, which have dropped significantly in the recent past.
“We expect that depending on relative valuations, we will continue to see inflows into and outflows from the emerging market debt asset class during the year.”
Emerging market countries: How policymakers have improved creditworthiness
• Reduction in external debt levels
• Liberalisation of fixed exchange rate regimes
• Build-up of significant foreign exchange reserves
• Adoption of inflation targeting
• Recognition of the importance of medium-term fiscal targeting as a key policy anchor
• Enhancement of the rule of law, corporate governance and international accounting standards
• Targeted development of domestic capital markets
• Removal of barriers to trade and to free flow of capital
Source: ING Investment Management
