EM bonds more attractive than equities, says Western Asset’s Robert Abad

Robert Abad, portfolio manager at Legg Mason subsidiary Western Asset, believes emerging market equities remain more volatile than bonds.

Sharp bouts of volatility stemming from US, Europe and China related growth fears have helped to extend EM equities’ record of poor risk-adjusted returns relative to EM debt. As a result, we are seeing more traditional holders of EM equity considering a partial or outright reallocation to sovereign and/or corporate credit.

During recent periods of market duress, we have witnessed a flight-to-quality within EM, where funds move out of higher-beta equities and currencies into lower-beta areas such as high-grade USD-denominated EM sovereign and corporate credit.

This supports our argument that investors recognise the stronger fundamental position of EM no longer justifies a wholesale liquidation of exposure during crises, nor an outsized spread premium relative to the developed world.

As we have argued before, balance-sheet strength and policy flexibility matter more for EM in this global macro environment than does their ability to sustain the high growth rates to which investors have been accustomed.

From a technical perspective, outperformance among EM since 2008 has attracted a diverse mix of new investment flows and we continue to see a broadening and deepening of the investor base.

Investing in EM local markets remains an attractive fundamental story over the long term. Shorter term, however, given the high and positive correlation of EM currencies to global markets and possibility of another round of macro-prudential measures, the risk/reward balance currently favors EM USD-denominated debt.


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