Managers review categorisation, allocation to Emerging Market Debt

With sustained economic growth, low debt levels and favourable demographics, Emerging Markets have been a favourite for all kinds of investors for some time, but managers are reviewing how emerging markets are defined and allocations to them within global debt and equity portfolios.

Emerging markets have delivered such healthy returns, especially against the paltry yields available elsewhere, that some analysts have warned of a “bubble” as money pours into dedicated funds, several of which have introduced front end fees to deter inflows.

Yet others are convinced that the asset class and opportunities within it, have more to offer. A report from London-based data and research firm Clear Path Analysis details investment considerations for EM debt and FX investing.

It cites Gregoire Haenni, chief investment officer, CERN Pension Fund, on the re-rating of Asian sovereign debt on the back of fiscal discipline, underlying economic growth which has capped government debt to GDP, and trade surpluses which have helped build up foreign exchange reserves.

“You’ve probably heard the consumer theme where EMs in Asia are shifting their economies from an export driven model towards a domestic consumption model – this is very true across most of Asia,” says Haenni.

“This (also) shows they are going to be less inclined to keep their currency weak because their economic model becomes less export driven. Our fear is that over time, they may become less inclined to buy US treasuries, possibly resulting in long-term risk. This young and growing population will soon have a buying power and this will change the dynamics in Asia and Ems.”

Jonathan Mann, head of Emerging Market Debt at F&C, points to the robustness of emerging economies and the strength of their sovereign balance sheets over the period since 2007, with consistent credit rating upgrades and the number countries issuing offshore sovereign bonds denominated in US dollars climbing to 57 from 36.

“New issuers we can expect to see come to market this year may include Kenya, Bangladesh and Thailand,” he notes, adding that investors generally are prepared to look further afield to secure yield and capital growth.

“There is return potential from accessing this new generation of countries on an opportunistic basis, increasing allocations within a more mainstream portfolio when conditions are supportive. Examples of these countries include Angola and Azerbaijan.”

He warns that returns will be balanced by higher associated risk. “Key to success will be the detailed understanding of the political and economic drivers at work within each economy.”

Greg Saichin, head of Emerging Market and High Yield at Pioneer Investments, told Clear Path Analysis of the potential returns from EM corporate debt. Before 2008, a preferred method of accessing capital for Emerging Market companies was via syndicated loans, he noted.

In 2007, banks wrote $400m in syndicated loans in Emerging Markets. Between 2009 and 2010, as Chinese GDP growth accelerated from 6.2% in Q1 2009 to 11.9% in Q1 2010, syndicated loan volumes dropped to $175m, pushing emerging market companies toward the bond markets.

The result: between 2008 and 2012, total emerging market corporate debt stock doubled. The recent shortage of emerging market sovereign bonds “has simply underscored the appeal of corporate (debt)”, he explained.

The emerging markets debt total market size is estimated to be $11trn, with $3trn being investable bonds. Many managers believe institutional investors in developed markets still hold too little in emerging markets, given their growing contribution to global GDP, and a re-balancing will have to occur, pushing up demand.

Bernhard Koeck, asset manager at VBV Pensionskasse notes that local currency debt “has become a very big market with countries who are wishing to issue currency debt in the same way they receive their revenues”. It also offers exposure to currencies and emerging market yields, which provide investors with two different sources of return within one strategy.

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