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by Thomas Strohm, Euro am Sonntag
R.Ready to get started, emerging market bonds as a catalyst for the 2021 portfolio, thumbs up for emerging countries – these were the almost euphoric assessments of investment strategists at the turn of the year. And now? Shortly before the middle of the year there are negative signs in the performance of indices and funds in the bond segment.
The main reasons for this are rising interest rates in the US and turbulence in various emerging countries. Data from the World Bank Association IIF show that investors continue to regard the asset class as attractive: In May, foreign investors invested $ 9.8 billion in emerging market bonds, while only four billion went into emerging market shares.
“For more than half a year now, owners of emerging market bonds have had to pretend that their asset class is becoming less attractive in view of rising US interest rates,” explain the experts at fund provider DWS. If US yields rise, the owners of US government bonds would initially have to accept price losses. Whether the loss on emerging market bonds is greater or less depends above all on how their spreads develop, i.e. the risk premium compared to fail-safe US government bonds. And most recently, these spreads would have narrowed if interest rates had risen in the USA. “In this way, the price loss that went hand in hand with the increase in US yields could be partially compensated,” said DWS.
If more capital had flowed from emerging markets to the US because of higher US interest rates, the spread would have widened. Emerging markets only attract quick money, which flows out just as quickly in the event of turbulence or poorer returns in the developed markets? According to DWS, investors should say goodbye to such prejudices.
For many emerging countries the risk premiums have shrunk almost to the pre-Corona level, for other emerging markets they are still significantly higher. The same is true of credit ratings: the spreads for bonds with investment grade ratings are only slightly higher, while the risk premium in the high-yield segment is well above the values before the crisis. Bulging negative headlines could confirm the impression that emerging markets deserve a high risk premium. “We, however, believe that the spread reflects the risks more than adequately,” say the DWS experts.
Alejandro Arevalo, Head of Emerging Market Debt at Jupiter Asset Management, cites a number of surprising events that would have caused higher volatility as a further reason for the poor development. In March, the Turkish President Recep Tayyip Erdogan fired the head of the central bank, who was considered market-friendly, whereupon the Turkish lira collapsed. Rumors circulated in April that Chinese asset manager Huarong was preparing to default on its foreign debt. There were fears that the simmering conflict between Ukraine and Russia could escalate. In Peru, the left-wing candidate Pedro Castillo surprisingly won the first round of the presidential elections, and apparently won last Sunday’s runoff election by a tiny margin.
Arevalo interprets the reaction of investors to the rising US interest rates and the four mentioned events as definitely positive for the bond segment. “The fact that the main driver of performance was the sell-off in US Treasuries is a sign that the asset class is behaving as one would expect developed country bonds to do,” he said. The surprises in the four countries have also been overcome: “In none of the regions was there any contagion to other emerging countries or within the entire asset class,” says Arevalo.
What has been observed so far in 2021 ultimately points to the increasing maturity of emerging market bonds as an asset class. “The shocks and turmoil that we experienced in the past are a thing of the past. At the same time, emerging market bonds are one of the few asset classes where investors can still find healthy returns,” said Arevalo.
How does it go from here? The strategists at Degroof Petercam Asset Management (DPAM) point out that many emerging countries are still well behind the developed economies in terms of vaccination progress and growth recovery. “The relevant gap between emerging and industrialized countries will decrease again,” said portfolio manager Hugo Verdire. Also because the emerging countries as suppliers and raw material exporters will benefit from the rising private and industrial demand in the developed countries.
In the Monetary policy of the central banks there are big differences. “Some have already raised key rates, such as Brazil or Russia, while others have eased them further, such as Romania or Mexico,” said Verdire. Last year, aggressive rate cuts would have weighed on many emerging market currencies. “The bottoming out of key rates should be supportive for currencies,” said Verdire. The share of currency income in the investment result of emerging market bonds should thus increase.
At Jupiter, Arevalo currently has a regional overweight in Latin America. There he sees opportunities in bonds that have benefited from higher raw material and energy prices. In addition, the fundamentals of selected government issuers in Africa were convincing. Asia is underweighted, as a large part of the post-crisis recovery has already taken place there. How important a broad investment is, for example, had shown the fluctuations as a result of the rumors about Huarong.
“All in all, the emerging economies are macroeconomically more solid today than they were a decade or two ago,” state the DWS experts. Nonetheless, the asset class remains very heterogeneous. After the market collapse in spring 2020, there were plenty of opportunities, now we have to make more choices again. “Even if it cannot be ruled out that political headlines could cause volatility in the short term, long-term investors should break free of old thought patterns and pay more attention to emerging market bonds solely for reasons of diversification,” says DWS.
The fund invests in emerging market bonds that governments or companies issue in dollars or euros; the currency risk for local investors is hedged. Romania, Indonesia, Chile and Mexico currently have the largest shares in the portfolio. The average rating is “BBB” and the return on the securities in the portfolio was most recently 1.7 percent per annum. The fund will be in the red in 2021; over a ten-year horizon, with relatively low volatility, it generated an average annual return of around 3.5 percent.
Investors with the DPAM fund invest in government bonds issued in local currencies. Certain countries such as China or Russia are excluded because of the sustainability approach. South Africa, Mexico and Indonesia currently have the greatest weight. In terms of ratings, the focus is on the “BBB” area. This fund is also in the red so far in 2021. In the past five years it has brought an average return of around four percent per year.
The fund invests in bonds issued by companies based in emerging markets. Exchange rate risks are usually hedged against the euro. China, Mexico and Brazil currently have the largest share regionally. The average rating is “BB”. The return on securities in the portfolio was recently 3.6 percent. So far there has been a minus for 2021. Over a ten-year perspective, the fund produced an average annual return of around five percent.
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