Is EM debt the obvious buy for bond investors after sell-off?
Bond fund managers have been returning to emerging market debt in the last few days following the dramatic sell-off in the sector, after a strengthening dollar sent prices spiralling.
Emerging market debt has been one of the biggest losers within bond markets in the last few weeks, as the resurgent US dollar – boosted by hopes of a fast-paced recovery in the US – weighed on returns.
In dollar terms, the JPM GBI EM Global Diversified index is down 4.8% in the last week alone.
Credit spreads have also blown out, with the JPM EMBI Global Diversified index of EM sovereign debt widening 85bps since early May.
However after such a volatile and aggressive tumble, bond fund managers are now spying opportunities in the sector.
Michael Mabbutt, manager of the Liontrust Global Strategic Bond fund, said the general “panic at the prospect of tighter global liquidity conditions” has sent local currency government debt spiking, leaving yields well above inflation rates in some countries.
“Our view is that the real yields that have opened up in some EM sovereigns are compelling,” he said.
He noted the 10-year Brazilian real-denominated government bond yield has spiked to 11.5%, even though inflation in the country is currently 6.5%.
“We see potential for significant capital gains from these levels, driven by the reversion of nominal yields curves to levels better reflective of underlying growth and inflation, so long as central banks react to inflation and currency volatility in an orthodox fashion.”
Thanasis Petronikolos, head of EM debt at Baring Asset Management, added recent moves in prices have been “alarming” for investors, but he said previous monetary policy-driven sell-offs have actually been great entry points for investors to buy into EM debt.
“We see a clear parallel to 2004 when the Fed lifted US interest rates from 1% to 5.25% over a two-year period,” he said.
Petronikolos (pictured) said following some volatility at the time, EM debt went on to produce impressive returns that year (over 20%) followed by positive spells in 2005 and 2006.
“We see potential for a similar scenario to play out over the coming months, and we believe the recent sell-off has created an attractive opportunity for investors.”
This article was first published on Investment Week