Investors underestimate the relative value of emerging market bonds and often overlook the benefits they add to a diversified fixed income portfolio.
Indeed, the lack of appreciation for this category is analogous to the initial prejudice towards Californian wines compared with French wines, until a “blind tasting” of vintages in Paris in 1976 shocked the Gallic vintners when the new world wines took the top places, according to Alan Siow, co-head of emerging markets corporate debt at Ninety One.
“A blind tasting in global fixed income markets can reveal similar surprises,” he told FSA.
Ninety One has a different perspective of investing, as a result of its emerging market (EM) pedigree and heritage. It believes that there is value to be added away from traditional credit via less mainstream, specialist credit.
A blind tasting of fixed income bonds can produce surprising results. Bonds backed by superior macro and fundamental factors, higher yields (and spreads), and lower durations are sometimes assigned similar or lower credit ratings.
“Therefore, investors who are guided solely by labels or ratings often miss out,” said Siow (pictured).
For his initial tasting guide, asset classes are analysed and compared for inflation trends, monetary and fiscal policy, potential for political disruption, debt-to-GDP ratios and geopolitical risk.
Siow finds that “many top-down factors favour emerging markets”.
Credit quality
Within these asset classes, further evaluation then comprises several disciplines: yield is used as the metric for the potential return of the asst class, and duration represents the interest rate risk in the asset class.
“Emerging market sovereign and corporate credit offer compelling opportunities across both investment grade (IG) and high yield (HY),” concluded Siow.
For example, a broadly representative single-A rated, EM IG corporate bonds yield 5.68% with a duration of 4.73 years, an EM IG sovereign bonds yield 5.8% with a duration of 7.58 years while US IG corporate bonds yield only 5.36% with a duration of 6.54 years, according to J.P. Morgan, ICE BofA Merrill Lynch data at 31 December 2024. (note, all US dollars).
“Clearly, EM IG corporate bonds offer the best value, with a superior risk-return potential,” said Siow.
For sub-investment grade BB- bonds the pattern is similar. On average, EM HY corporate bonds yield 8.17% with a duration of 3.30 years, EM HY sovereign bonds yield 10.14% with a duration of 5.55 years and US HY corporate bond yield 7.47% with a duration of 3.37 years, the same sources show.
This blind taste can be further extended between bonds within market sectors, such as technology, gaming and utilities which can also unearth similar glaring anomalies.
“Essentially the markets often undervalue EM companies and their bond issues,” said Siow. “EM deserves a place in a bond portfolio, and alpha is delivered through individual selection.’
