Fixed income markets have had a difficult few months and, of the many different asset classes, emerging market debt has had to deal with the added challenge of negative sentiment towards emerging markets.
But with many strategic bonds emphasising the importance of diversification in their portfolios, is there a place for emerging market debt or should it be avoided?
The performance of the average IA Global Emerging Market Bond fund in the five years to March 22 2016 has been a positive 12.5 per cent, compared with the IA Sterling Strategic Bond average return of 26.2 per cent, according to data from FE Analytics.
In the shorter term, emerging market debt has performed better, with the IA Global Emerging Market Bond sector delivering an average return of 8.9 per cent for the year to date, compared with the IA Sterling Strategic Bond average return of just 1.2 per cent.
Omar Saeed, manager of the L&G Dynamic Bond Trust, points out: “Since mid-2013, emerging market debt issuers [have been] experiencing fundamental and structural challenges linked to the continued commodity sell-off, strengthening of the US dollar and reversal of the [US] Fed policy. It is unsurprising the asset class has fallen out of favour for strategic bond investors.”
He notes that while these challenges are expected to persist over the next one to two years, the indiscriminate nature of the sell-off has created decent relative value opportunities.
“As a result, we have allocated towards a select number of short-dated EMD government debt and quasi-sovereign issuers. A running yield of approximately 4.5 per cent per annum can be realised, [but] suffice to say solid stock selection will be absolutely key,” he adds.
EXPERT VIEW - Emerging market debt
Rodica Glavan, emerging market debt portfolio manager, Insight Investment, highlights the opportunities in a sometimes overlooked asset class:
“These credits are under-researched, under-owned and unloved by mainstream investors. This creates mispricing and opportunity in spite of EM corporate debt’s status as a rapidly maturing asset class. The share of corporate finance via bond markets in EM has nearly doubled since the global financial crisis as banks have aimed to deleverage and shrink their loan books.
“Headlines on emerging markets have been unremittingly bad. They have focused on the fear of a hard landing in China, the sharp decline in commodity prices and the perceived negative impact of an appreciating US dollar on debt sustainability.
“[But] technical factors are also beginning to support EM corporate debt. The outflows from the asset class and poor investor sentiment have made it a difficult climate for new issuance. In the final quarter of 2015 there was a net supply of -$30bn. We expect this trend to continue this year. Our estimates are that $158bn will be returned to investors in 2016 in coupon and principal repayments. Bond buybacks are also becoming more popular due to currency volatility and could amount to $50bn over the course of the year.”
Daniel McKernan, head of sterling investment grade credit at Standard Life Investments, notes the team behind the SLI Strategic Bond fund also has emerging market exposure, mainly for diversification purposes.