Emerging Market debt markets offer value and diversity

There are significant pockets of value in emerging markets debt with a wide variety of options for investors to access fixed income assets at a low cost, according to Francis Rodilosso, Senior Investment Officer for Van Eck Global’s Market Vector’s fixed income exchange traded funds (ETFs).  Mr Rodilosso said rising demand for emerging markets debt from pension funds and insurance companies should underpin ongoing demand.

“With developed market bonds yielding next to nothing and with ongoing concerns of deflation, real interest rates in emerging markets relative to the US have a real advantage beyond geographic diversification.

“Reflecting this, pension funds’ and insurance companies’ strategic holdings of emerging markets debt continue to grow as they seek to diversify their portfolios geographically. De-risking has caused a re-pricing of a large portion of emerging markets debt markets, more so than other global credit markets, which has added appeal to these types of investments,” said Mr Rodilosso.

“While local interest rates in many emerging markets should fall through 2015, currency depreciations against the US dollar  are likely to be larger drivers of returns. We already see emerging markets currencies adjusting for an upward trending US yield curve and a stronger US dollar, and clearly that is negatively impacting returns for US dollar based investors. The easing bias among a majority of major central banks in developed markets and emerging markets will also favour the performance of sovereign bonds against the backdrop of rising rates in the US.”

Mr Rodilosso said another factor favouring investment in emerging markets is generally more fiscally sound economies compared to the huge debt levels in developed nations.

“Following their own crises of the 1990’s and early 2000’s as well as the global financial crisis, many emerging markets have got their economies in far better order.  According to the IMF, gross government debt to GDP in emerging markets is 41% versus 114% to their developed market counterparts. Moreover, there are better growth fundamentals in emerging markets given the more severely ageing populations and declining birth rates in developed markets,” he said.

In addition, emerging markets allow investors to gain exposure to interest cycles that are at different stages of the cycle to developed markets.  “For example, South Africa and Israel policy rate direction is trending upwards, whereas in Turkey and Peru, interest rates coming down. Moreover, there has been growth of local currency and corporate markets since 2007, so the availability of quality investments is growing quickly on a global scale, giving increasing importance to the emerging debt markets,” said Mr Rodilosso.

“China’s onshore bond market has grown at an average annual rate of 23% over the past ten years. Historically, this market has been out of reach for foreign investors. But things are changing. Government-run quota systems are allowing foreign investors access to its fixed income markets, which is the third largest in the world.  Furthermore, despite concerns about its path for growth, remember that China is a AA rated country,” he said.

In terms of corporate credit, the local currency and hard currency corporate bond universes are expected to grow significantly in coming years. However, investors need to be on their guard.

“There are some very good corporates whose bonds appear cheap. Emerging markets seem to be hit harder by external factors. Russian corporates have been hit as were Brazilian corporates. We’ve seen volatility in the Chinese property sector and in energy bonds globally. These events add volatility and impact liquidity if investors start to worry and try to sell their whole portfolio; that is why diversification is important,” he said.

Van Eck Global is seeing more Australian institutions considering emerging market debt.