Mike Grdosic, Senior Investment Analyst, Lonsec Research and Ratings
Local Emerging Market Debt (EMD) government securities represent a differentiated asset class that can potentially offer diversifying benefits to portfolios. This is particularly relevant today, given rising levels of developed market government debt and potential ‘currency debasement’ risks. Moreover, developed market non-government marginal yields, e.g. corporate spreads, are also historically tight, making traditional ‘income’ securities appear less attractive.
Many traditional global debt managers opportunistically allocate small amounts to the EMD sector, but a dedicated exposure to a specialist manager is worth considering. This is due to the ability to control the EMD exposure size at the portfolio level and utilise specialist skills that can harness the idiosyncratic opportunities. Further, changing fundamentals between developed and emerging economies imply shifting relationships to risks, where local EMD may be more diversifying on a forward-looking basis.
Local EMD fundamentals and benchmark characteristics
Local EMD outstanding is estimated by JP Morgan to be around USD13 trillion, a relatively large universe but much lower than developed market debt, which is estimated by Fitch to be around USD64 trillion, as at the end of 2024. In contrast, the World Bank estimates the emerging economies now account for around 45% of global GDP (on a nominal basis), whilst on a purchasing-power-parity (PPP) basis, it’s over 60%. This implies a higher income base to support debt levels, relative to developed markets.
Local EMD, as represented by the ‘JP Morgan Government Bond Index – Emerging Markets (GBI-EM) Global Diversified’, has several characteristics worth highlighting:
- 80% of securities are BBB and above
- Local yields can be moderate to high – e.g. 6 – 13% (Brazil)
- Historic volatility, circa 8%, similar to property and high yield bonds
- Interest rate duration risk of around 5 to 6 ‘years’, similar to the Australian bond index
- Historical correlations to major asset classes are low to moderate
- Correlations to listed equities in risk-off periods have in the past tended to be higher, although not too dissimilar to corporate high yield bonds
- Low cross-correlations within EM countries, which assist with active management
- Currency volatility can dominate short-term returns, whilst high starting yields assist performance over the medium to long term
- Top ten countries: Indonesia, China, India, Mexico, Thailand, Poland, South Africa, Brazil, Czech Republic, Columbia and Romania.
EMD manager coverage
Lonsec EMD active manager coverage is relatively narrow, comprising four managers. However, most are highly rated and offer differentiated approaches. These are summarised below:
- Colchester: benchmark aware, fundamental process but systematically applied, focused on sovereign bonds
- VanEck: fundamental top down and bottom up, covers both local, hard currency EMD as well as opportunistic exposures to corporate debt
- Finisterre: discretionary top-down approach, with a more absolute return focus and an emphasis on downside protection with relatively strong use of derivatives
- Antipodes: Asian EMD-focused fund targeting higher yields with a focus on corporates
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