Investors should think of EM bonds as insurance

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Jan Dehn, head of Research and Gustavo Medeiros, portfolio manager at Ashmore discuss and quantify the yield differentials in the Developed and Emerging Markets.

Developed Markets bonds offer negative yields, suffer from poor long-term macroeconomic policies and have exposure to debt levels that pose major risks for bond holders in the future, in our view.

By contrast, Emerging Markets (EM) fixed income is not only relatively cheap, but also backed by much stronger economic dynamics and far less debt.

Two year and five year government yields in developed economies are now negative on average. To argue that these markets are not in a bubble is becoming less and less credible. Investors in developed market bonds are literally paying for the privilege of lending money to over-indebted, money-printing, reform-shunning developed market governments. These governments are the most heavily indebted in the world with debt ratios of 138.5% of GDP, according to 2014 IMF data.

Some $105trn of the world’s $120trn of bonds – 87.5% of the total – have been issued by developed economies despite that fact that developed economies only make up 44% of global GDP. To make matters worse, these economies are also pursuing policies that are likely to lead to losses for fixed income investors.

In the seven years since the Subprime Crisis, developed economies have undertaken virtually no reforms at all. Nor have they achieved any meaningful aggregate deleveraging – in fact issuers and investors alike appear to completely ignore the debt problem, perhaps because debt is easy to ignore when interest rates are zero. Instead, they have printed a staggering amount of money.

In a nutshell, these countries are all desperately trying to convert their debt problem into an inflation problem. They will eventually succeed, so the outlook for returns in these markets is ultimately dismal, because it hinges on continuing to inflate a bubble. The fact that a huge chunk of the world’s savings are parked in these fixed income markets means that the outlook for future generations is bleak.

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