Emerging market (EM) assets, both equity and fixed income, are now attracting attention, having been out of favour for a while.
U.S. dollar weakness, oil price stabilisation and subsiding fears of the yuan devaluation and a possible ‘hard-landing’ for China’s economy drove a recent relief rally in EM assets. We realise that financial markets are likely to remain volatile – and no exposure divides investor opinion as much as EM – but several headwinds for EM such as weak commodity might be less of an issue going forward.
In EMEA and U.S. domiciled exchange-traded products (ETP), we have seen investor re-positioning from under-owned levels in EM equities to less underweight with US$8.95 billion flows in March 2016 (BlackRock, 31/03/2016).
Against a backdrop of negative interest rates in Europe and Japan, it is increasingly difficult to find higher yielding assets. Emerging market debt (EMD) may offer opportunities. Credit quality has improved over the last decade and is converging with that in developed economies. In December 2005, 39% of EMD was rated investment grade whereas 61% was rated high yield. A decade on in December 2015, over 50% of EMD is now classified as investment grade (BlackRock, Bloomberg, JP Morgan, 31/12/2015).
Emerging market bonds are either issued in the local currency of each country or in ‘hard currency’, mainly U.S. dollar. Government EMD currently provides some of the highest yields in the fixed income universe - higher than similarly-rated corporate debt in developed economies. For example, U.S. dollar-denominated EMD, as represented by the JP Morgan EMBI Global Diversified Index yields approximately 5.5% despite over 50% of its constituents being investment grade-rated. Meanwhile, local currency EMD yields some 6.4% (Bloomberg, as at 02/04/2016). We prefer local currency EMD given that EM currencies, beaten up in recent years versus the U.S. dollar, could still have room to catch up further. Oil price stabilisation may also provide some support.
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