Joon Hyuk Heo (pictured) is head of global fixed income at Mirae Asset Global Investments.
The search for yield is one of the greatest challenges in today’s market environment. We believe low interest rates in developed economies are a result of a combination of factors such as an ageing population, polarization of wealth, and investments in capital-light businesses and automation.
These are structural issues, so any temporary rise in yields due to raising policy rates or ending the QE is unlikely to alter the secular low interest rate environment.
The market is anticipating the US Federal Reserve to raise interest rate, but such incident does not necessarily mean that EM debt will be affected negatively. Historically, when DM banks were the main money suppliers in EM external funding, any monetary policy changes by DM central banks would lead to a sell-off in EM assets. This is no longer the case. Today, a large amount of external funding is through long maturity bonds offered by EM governments and EM corporates.
Local debt markets have also significantly improved and are able to provide a buffer if there was a liquidity shortage from DM banks. So when we think about EM investments, DM central banks’ policy changes would be just one risk factor that we would take into consideration. We would also look at each EM country’s idiosyncratic risk factors such as trade and FX reserves which are improving globally. Also, a DM central bank’s exit from easing monetary policy will likely happen slowly and can take at least 2 to 3 years.
To look for better risk-adjust returns, shorter duration emerging market debt (EMD) looks attractive. For example, emerging market (EM) US dollar sovereign yield around 5.45% with a duration of 6.8 years. Now compare this with developed market (DM) treasuries, the GBI index yield is 1.36% and has duration of around 7.9 years, and the value premium is clear.
A majority of EMD is investment grade and defaults are low. EM seems to offer a diverse opportunity set, which means managers doing their research can uncover far greater idiosyncratic opportunities and alpha compared to DM.
Most EM countries now have large FX reserves to protect against systematic risks. The inflation spread between developed and developing countries is at its lowest point in two decades and EMs are better positioned to deal with tighter monetary conditions in the short term.
From a macro standpoint, EM growth is robust and is estimated to reach around 4.5% this year.
The growth differential between EM and DM is likely to remain high at around 3% for the next few years, commodities are trading in a range, most EM currencies remained stable despite a rising US interest rates, and the strength of the US dollar has arguably peaked. All of these factors are broadly supportive of EMD. These improving conditions and the search for yield should fuel demand for EMD.
Local currency debt offers higher yields compared to comparable EM dollar bonds. And EM currencies, especially in Asia, have been very stable over the last few quarters. We still think EM currencies are somewhat undervalued on some metrics.
Compare that to a relatively weak dollar this year, there is a strong argument for investing in EM debt.
Rapid growth and reforms in many EM countries have also led to significant improvement in the credit quality of dollar denominated debt. And while yields have fallen recently, it still offers a significant spread over DM.
Our strategy is to dynamically allocate risks across different sectors in this ever changing macroeconomic environment.
Given the improving fundamentals of emerging markets, the issuance of investment grade rated bonds is increasing. EM corporate debt offers attractive yields relative to similarly rated debt in the developed world. The EM corporate debt universe is diverse and offers opportunity to get exposure to all major industries across all geographic regions.