Simon says the level of yield on a hard currency emerging market bond is closely linked to the yield on a US Treasury bond, but this relationship is inversely correlated – that is, if the price of US government debt is rising, in normal market conditions, the price of emerging market debt would be expected to fall.
In that way, the asset classes are inversely correlated and so emerging market debt can be said to be a diversifier, at least in theory.
And in practice, Simon says at the current pricing levels emerging market bonds can deliver returns similar to equities, but are sufficiently lowly priced that they could potentially have only the volatility level of bonds right now.
Cash on the hip
The second related issue is around liquidity. The liquidity of the emerging market currency is obviously relevant, but then comes the issue of the liquidity of the bond – in normal times there would be less volume traded in emerging market local currency than in emerging market hard currency debt.
Kynge says: “Our preference would be for emerging market government bonds denominated in local currency that have sufficient liquidity to allow for flexible trading. Our preference for liquidity at this stage relates to the uncertainty of global growth.
"In the event of a global recession, the US dollar’s role as the global reserve currency would likely lead to strengthening and, therefore, currency losses on emerging market currency bonds.”
Dimitry Griko, a specialist emerging market debt investor at Arkaim Advisors, says many parts of the emerging market corporate bond universe presently trade at prices below the 'recovery' level of the bonds, that is, the price of the bonds is presently lower than the cash a creditor could expect if the companies actually defaulted.
Apart from valuation, his principal argument in favour of emerging market debt right now is that, in his view, the performance of the asset class is relatively uncorrelated with that of wider debt markets.
He adds that the outflows that were a feature of the sector in recent years have started to reverse, and if the sector begins to attract inflows, that is a positive both from the point of view of performance, and also of liquidity, as inflows mean there are more buyers than sellers.
Kevin Thozet, a member of the investment at Carmignac, says many emerging market central banks put interest rates up to combat inflation some time ago, and this means if they feel the need to stimulate economic growth, they have the capacity to cut interest rates.
A central bank cutting rates would normally be expected to boost the price of the government bonds of that country, as future bonds will have an interest rate reflecting the new, lower base rate, while the bonds already in issue will have an interest rate that reflects the previous, higher interest rates.
