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Emerging market debt best positioned in decades

Equities

The search for diversification has forced financial advisers to look far and wide as they seek non-correlated opportunities to fortify client portfolios. Among the most popular asset class in recent months have been emerging market equities, primarily those focused on China and Asia.

  • As is typically the case, equity markets get all the attention and capital flows, given their comparative sexiness against old-fashioned bonds, but is the tide beginning to turn? According to the emerging market specialists at Eaton Vance, emerging market debt has been flagged as a clear ‘overweight’ for portfolios.

    Long considered as higher-risk by many investors, the region’s stellar track record during the pandemic, more conservative fiscal and monetary policy settings, and a recent weakening in the US$ are driving an increase in interest. And that is without mentioning the yields on offer, which can be four to five times higher than the 10-year US Treasury yield at 1.1%.

    The Eaton Vance emerging market debt (EMD) team, which manages US$8.4 billion ($10.8 billion) in assets, is positive on all aspects of the sector, including interest rates, sovereign and corporate credit. According to Michael Cirami, director of global income and portfolio manager on Eaton Vance’s global income team, the “reasons for this bullish stance include dovish policies of G3 central banks, low yields in core bond markets, increasing deficits in the US and attractive relative valuations” – a near-perfect storm, it would seem.

    The EMD team currently prefers local-currency-issued debt, rather than hard-currency bonds in US$, noting five key reasons. The first is the fact that “emerging economies are driving the rebound in global economic growth” by virtue of their relative success in combating the virus. Strong economies bode well for the strength of their domestic currencies, which have always been a risk of EM debt.

    Second is the fact that emerging market debt has not seen the spread contraction that developed market bonds have seen, meaning they are likely to be less prone to a jump in bond rates in future. This leads to the third positive, being that the success of emerging markets in 2020 has not been priced into markets, despite one of the best macro outlooks in decades.

    Finally it has been about issuance. While early in 2020 there were concerns about corporate issuers and the dual threat or solvency and liquidity, which reduced demand, this has turned the corner in the second half, with capital markets ‘wide open’ once again.

    Cirami does offer caution, adding that “while highlighting specific opportunities, it is worth highlighting that, within EMD, investors need to be careful and selective when approaching this highly differentiated asset class. On the flip side to the investment opportunities we have mentioned, there is also the growing problem in some countries of budget deficits and debt buildup,” he adds.


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