Focus on emerging markets – Swiss & Global’s Ghidini favours Mexico linkers

Due to their compelling valuation, emerging market linked bonds continue to materially outperform the other sub-asset classes within the emerging market local space over one, three and five years.

Over five years, emerging market linkers have outperformed local nominal bonds and emerging market currencies/money market by 18.34% and 34.27% respectively.

In June Mexico was the big outperformer in terms of interest rates (real rates and inflation), supported by general improvement in global risk appetite, supportive domestic economic numbers and political developments.

The JB Emerging Markets Inflation Linked Bond Fund has profited from this.

In terms of relative performance, the fund’s long exposure in Mexico (both rates and currency) was the main positive contributor, together with the security selection in Brazil.

The outlook for emerging market linked bonds remains positive as the debt dynamics of emerging market countries are solid, and on an improving trajectory due to healthy economic growth and sound fiscal positions.

From a valuation perspective, the asset class offers real yields above 3%, which is particularly attractive compared to negative real yields in many parts of the developed world.

We continue to favour Mexico, Brazil, Uruguay and Israel, where high yields go hand in hand with robust fundamentals.

Historically the asset class outperformed other investments in local emerging markets, notably money markets (pure local currency exposure) and nominal bonds. Based on current valuations, we believe that this trend is likely to continue.

Inflation-linked bonds offer considerable steepness in local yield curves which makes bond markets more attractive than pure currency exposures for investors looking for high, sustainable long-term performance.

Money market yields are around 4%, while emerging market linkers offer a running yield of close to 9%.

They also offer reasonably cheap inflation protection and this is particularly relevant in the current economic cycle. It makes sense to buy linkers when inflation rates and expectations are easing cyclically and when long term, structural protection is becoming cheaper.

Alessandro Ghidini is co-fund manager of the JB Emerging Markets Inflation Linked Bond Fund, at Swiss & Global Asset Management

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