Unravelling myths: The hidden truths of Emerging Markets Debt
The EMD HC Team highlight how emerging markets debt (EMD) has evolved into a rapidly growing and maturing asset class, one which deserves closer attention from investors seeking diversified and resilient portfolios with attractive long-term return potential.
6 minute read
Key takeaways:
- The hard currency sovereign universe (EMD HC) is now a mature asset class spanning over 70 countries across the full ratings spectrum, with 50% of the universe rated investment grade. The breadth of countries brings fundamental diversification of risk (versus domestic US-dollar denominated assets) within an investor’s portfolio.
- EMD HC provides investors with access to the EM “risk premium” combined with the more defensive properties of bonds.
- Investment outcomes can be enhanced through active management due to the complexity of the asset class and prevailing market inefficiencies.
Emerging markets (EMs) as an asset class have been accessible for over two decades, yet misconceptions surrounding them continue to deter some investors. Despite EMs accounting for over 60% of global gross domestic product (GDP) and being home to nearly 90% of the world’s population,[1] European investors have on average a 6% allocation to EMD in their portfolios.[2] Many miss the chance therefore to diversify their portfolios by not incorporating exposure to EMs.
Some of the key attributes of Emerging Markets Debt Hard Currency (“EMD HC”) are:
- Attractive yields: EMD HC offers yields that are much higher when compared to developed market (DM) debt, with a significant portion of the universe rated investment grade (IG), presenting robust return potential over the long term.
- Resilience and stability: Despite preconceptions, EM countries have demonstrated marked improvement in economic fundamentals, making them more resilient to global economic shifts.
- Diversification: EMD HC provides fundamental diversification of risk by offering exposure to a multifaceted range of countries. It provides access to the EM risk premium combined with the more defensive properties associated with hard currency (HC) bonds.
- Active management opportunities: The complexity and inefficiencies inherent in the asset class necessitate active management strategies to successfully navigate and capitalise on opportunities that, in our view, indices and passive exchange-traded funds (ETFs) overlook.
In this paper, we address key misconceptions about EMs that may be preventing investors from embracing this asset class, with a specific focus on hard currency EM sovereign debt. We highlight how EMD has evolved into a rapidly growing and maturing asset class, one which deserves closer attention from investors seeking diversified and resilient portfolios with attractive long-term return potential.
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These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.
Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
There is no guarantee that past trends will continue, or forecasts will be realised.
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Important information
Please read the following important information regarding funds related to this article.
- An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall. High yielding (non-investment grade) bonds are more speculative and more sensitive to adverse changes in market conditions.
- When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise (or are expected to rise). This risk is typically greater the longer the maturity of a bond investment.
- Some bonds (callable bonds) allow their issuers the right to repay capital early or to extend the maturity. Issuers may exercise these rights when favourable to them and as a result the value of the Fund may be impacted.
- Emerging markets expose the Fund to higher volatility and greater risk of loss than developed markets; they are susceptible to adverse political and economic events, and may be less well regulated with less robust custody and settlement procedures.
- The Fund may use derivatives to help achieve its investment objective. This can result in leverage (higher levels of debt), which can magnify an investment outcome. Gains or losses to the Fund may therefore be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
- When the Fund, or a share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency (hedge), the hedging strategy itself may positively or negatively impact the value of the Fund due to differences in short-term interest rates between the currencies.
- Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
- The Fund may incur a higher level of transaction costs as a result of investing in less actively traded or less developed markets compared to a fund that invests in more active/developed markets.
- Some or all of the ongoing charges may be taken from capital, which may erode capital or reduce potential for capital growth.
- The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.
Specific risks
6 minute read
Key takeaways:
- The hard currency sovereign universe (EMD HC) is now a mature asset class spanning over 70 countries across the full ratings spectrum, with 50% of the universe rated investment grade. The breadth of countries brings fundamental diversification of risk (versus domestic US-dollar denominated assets) within an investor’s portfolio.
- EMD HC provides investors with access to the EM “risk premium” combined with the more defensive properties of bonds.
- Investment outcomes can be enhanced through active management due to the complexity of the asset class and prevailing market inefficiencies.