Investors should be seeking local currency emerging markets (EM) debt to counter lack of yield in developed markets’ government bonds, investment managers have indicated, with Australians potentially placed to benefit more than their overseas counterparts.
Currently, EM debt makes up 8 per cent of the global bond market cap, having risen from 2 per cent over 20 years.
American-based MFS Investment Management is currently looking to build up its EM debt offering in Australia, having established its equities range.
MFS emerging markets debt portfolio manager Ward Brown believes EM debt is no longer perceived to be a tactical trade and warrants a more long-term strategic allocation in portfolios, as fundamentals have improved, its investor base is more stable and issuer base has grown.
Investors stand to gain from local sovereign currencies not being as well defined in EM bond issues, Mr Ward added, as they have yet to develop to infrastructure for pricing.
“One of the great features of emerging market debt is that the market doesn’t price that sovereign risk very efficiently. So there’s lots of mispriced assets in the class,” he said.
“For example, they haven’t priced the sovereign risk here or they priced way too little risk. And what that allows investors to do, and what we try to take advantage of, is finding good alpha opportunities; that is, investments that are going to offer you better reward for the risk of taking it.”
Mr Ward added that Aussies could benefit more from the space than investors in other developed markets.
“Emerging market debt perhaps offers the most benefits to that investor over others in developed markets, because of the way the Australian dollar is correlated with emerging market debt returns,” he said.
“In our asset class, the properties of diversification and enhancing their return for a certain level of risk are even stronger in a number of Australian portfolios that we looked at.”
MFS senior managing director and head of Australia and New Zealand Marian Poirier added that for Australian superannuation investments, having a strategic longer term in the asset class made sense.
Fellow fund manager Eaton Vance noted that real yields are higher in EM countries, with many trading at historically high levels.
The company said it has been a decade since the end of the global financial crisis and there is still more than $12 trillion worth of government debt trading at negative yields, including in the Eurozone, Switzerland and Japan.
“Even in the US, five-year Treasury yields are negative when deflated by inflation expectations. Around the globe, many central banks, including the US Federal Reserve and the European Central Bank, are contemplating looser monetary policy in light of weaker global growth and low inflation,” the emerging markets debt team at Eaton Vance said in a statement.
“Against this backdrop, EM local currency debt offers opportunity, even after the recent rally in yields. Local currency EM debt carries currency risk but minimal credit risk compared to hard currency EM debt.”
Mr Ward added that while central banks in developed markets could look to implement lower interest rates, investors can find high growth rates and diversification in EM debt.
“Investors looking for yield in government bonds who want to minimise credit risk should consider local currency EM debt,” Eaton Vance noted.
“Investors must carefully weigh ever-present political and currency risk in the asset class. But with due diligence, EM debt can offer relief from the negative rate blues in global government bond markets.”
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