This week Asset Allocator thought we’d take a look at the farther-flung regions of the fixed income universe: emerging market debt.
Much like emerging market equities, money is often the first to flow in, and the first to flow out when investors get flustered.
Though the US dollar remains strong, and despite heavy outflows over the past few years, some allocators see this as an opportune moment to invest in the asset class.
Recently we were told that Fidelity’s multi-asset team had taken a material position of 5 per cent in emerging market debt – much larger than our database shows for the average allocator we cover - at 2 per cent.
This got us thinking – is this shaping up as a wider valuation call for DFMs?
We talked to the team at YOU Asset Management, who told us that local currency EMD is by far and away their preferred form of carry in the current environment.
They get this exposure via the Eaton Vance Emerging Market Local Income fund, which is now part of Morgan Stanley. It generates a running yield of around 15 per cent, which they find ‘exceptionally attractive’, given they see macro tailwinds of rate-cutting cycles and a weaker dollar on its way.
The mandate roams over yonder when seeking opportunities in the space.
“Often the best opportunities are found away from the large benchmark countries such as Mexico, Brazil and Thailand and in farther-flung locales which require deep technical trading capabilities to access efficiently,” said Cormac Nevin, portfolio manager at YOU.
“Many emerging nations employ capital controls of one form or another and Eaton Vance has developed industry-leading trading capabilities to capitalise on attractive opportunities in countries such as Egypt and Uzbekistan.”
Over the hedge
Whether or not the debt’s currency is hedged can significantly alter the outcome for investors, said Fahad Hassan, chief investment officer at Albemarle St Partners.
“While EM debt issued in US dollars can seem like a good option, a country’s ability to service debt in dollar debt is greatly inhibited in a crisis,” he said.
“Local currency debt offers the benefit of currency related gains if the economic backdrop improves. Local issuers on average have higher ratings and a greater ability to service debt during troubled times.”
However, he warned of the myriad pitfalls that this asset class could encounter.
“Risks remain, including global recession fears, geopolitical tensions, currency volatility, and idiosyncratic risks in countries like Turkey and Argentina,” he added. “Uncertainty around Fed policy also poses a challenge.”
One alternative for allocators is to meet in the middle between emerging and developed market debt. YOU uses Chinese onshore government debt and they said this has been a fantastic diversifier to portfolios.
They don’t consider it to be in the same vein as the Eaton Vance mandate, but said it offers low correlation with other fixed income products.
“This sub-asset class beautifully sidestepped the meltdown in global government bonds – and in particular UK gilts – during the inflationary shock we witnessed in 2022,” added Nevin.
“We continue to really like the exposure and express it via the JP Morgan China Aggregate ETF in our fund-of-funds.
"This is driven by the demographically induced deflationary morass China appears to be stuck in, as well as the exceptional yield enhancement that Chinese treasuries offer when hedged back to sterling.”
