Emerging markets winners and losers could surface in the bond market following the coronavirus pandemic, while longer duration government bonds from developed markets including US Treasuries could be crushed by rising interest rates and inflation in an eventual economic recovery.
The coronavirus has crushed global growth prospects and investors have flocked to “safe” or lower risk assets such as US Treasuries, which are trading near recod high values. That has forced yields on government bonds to historical low levels below 1 per cent in many developed nations and below 0 per cent in Germany, France and Switzerland, drastically hurting investors’ income streams.
Exacerbating the income drought, many companies previously relied upon by investors for their high shareholder payouts are no longer paying such high dividends. We have already seen that with National Australia Bank this month cutting its dividend payout by a whopping 64 per cent and ANZ deferring dividend payments to shareholders. The two other big banks could soon follow.
The yield drought will likely encourage investors to turn to emerging market bonds. When the coronavirus crisis passes, liquid emerging market sovereign bonds and liquid high-carrying local bonds could rally on strong demand. In their favour are many emerging markets that have implemented structural reforms that will carry them through the current crisis. These economic reforms, such as tightening up budgets, are why emerging markets performed so well after the GFC and could continue to do so after the coronavirus pandemic wanes.
Today, while the US, Australian and many European economies will drown under the weight of high levels of government and/or private-sector debt, much of it intended to offset the dire economic impact of the coronavirus, many emerging nations have lower debt levels or are net savers. Up until now, emerging market economies have been growing more strongly, generally speaking, than most developed nations and they are more structurally sound than in the past with lower levels of debt. Current accounts and government budgets are largely in check. Policymakers, appealing to ever-growing and better educated middle classes, are encouraging savings and pension reforms that have, until recent times, driven up capital investment. Over the longer-term, this is likely to persist.
Reflecting the appeal of emerging market bonds – and higher yields – institutions have been gravitating to emerging markets debt given relatively attractive yields while interest rates have plummeted on domestic bonds. Emerging nations, notwithstanding the coronavirus, are paving the path over the longer-term to higher incomes for investors.
During the current market disturbance, many emerging markets will benefit from government and banking support. The IMF is increasing its lending facilities. The G20 is looking to guarantee near-term US dollar payments on the Eurobonds of poorer and smaller countries. The Paris Club of rich bilateral lenders is looking to suspend debt payments by poorer emerging market countries. Swap lines with key emerging markets, like Mexico, reduce the risk of dollar runs becoming self-fulfilling. The US Federal Reserve is responding to every fire they see, and quickly, much more so than during the global financial crisis (GFC). This Fed action will also help stabilise emerging markets and maintain their potential for faster growth than developed nations, over the long-term.
Active management is key
Emerging market governments and corporations generally pay more on their bonds than their developed market counterparts, as the chart below shows. This is likely to remain the case through 2020.
We believe this presents an opportunity for investors to look beyond the past and move into emerging markets debt securities to fill out the income part of their portfolios with interest rates staying lower for longer in developed nations. Government bonds from developed nations, in contrast, risk being crushed by rising inflation, which could be brought about by huge levels of government expenditure.
Careful selection, however, is required of emerging market bonds as economic conditions vary from country to country, with active fund managers best placed to pinpoint favourable markets. A good investment will depend on country-specific factors and the winners and losers are best picked through an active fund manager that can sort through the detail. Some emerging markets bonds have done well in this current environment, like Czech, Thailand, and Philippines.
By investing through an active fund manager with expertise in the sector, investors can benefit from exposure to an optimal portfolio of emerging market bonds that are unconstrained by indices and invest in bonds that offer the best value relative to their fundamentals while managing risk. Investors can now more easily access emerging markets assets with exchange-traded funds on ASX. The VanEck Emerging Income Opportunities Active ETF (Managed Fund) (ASX: EBND) enables investors to access a diversified portfolio of emerging markets bonds via a single trade on ASX.
Arian Neiron, managing director – head of Asia Pacific, VanEck
Disclaimer: This information is issued by VanEck Investments Limited ABN 22 146 596 116 AFSL 416755 as the responsible entity of the VanEck Emerging Income Opportunities Active ETF (Managed Fund) (“EBND’). This is general information only about a financial product and not personal financial advice. It does not take into account any person’s individual objectives, financial situation or needs. EBND invests in emerging markets, which have specific and heightened risks that are in addition to the typical risks associated with investing in the Australian bond market. Before making an investment decision, you should read the PDS and with the assistance of a financial adviser consider if it is appropriate for your circumstances. The PDS is available at www.vaneck.com.au or by calling 1300 68 38 37. No member of the VanEck group guarantees the repayment of capital, the payment of income, performance, or any particular rate of return from EBND.