A reaction to the 2008/09 Global Financial Crisis, predominantly in the developed world, was for central bankers to pursue an unprecedented degree of financial manipulation in the setting of interest rates and in the form of Quantitative Easing – principally the buying of government bonds. Almost eight years on, and central bankers persist in intervening with bond buying programmes and the further lowering of interest rates. As a consequence, by mid-August 2016, some $13.4 trillion [data source: Fitch Ratings], approaching one-third of all outstanding global debt, was trading at a negative yield. However, whilst most of this is sovereign debt, the percentage of corporate bonds with negative yields is rising rapidly.
For a number of years we have pursued a cautious stance in regards to our fixed income strategy, taking the view that the Government Bond space, in particular, is in, or close to ‘bubble territory’. As part of this cautious approach, our preference has been to allocate to strategic bond fund managers who have the flexibility to invest right across the bond market spectrum and to actively manage their portfolios’ duration (sensitivity to interest rates).
With key headwinds, such as weak commodity prices, concerns over Chinese growth and a weaker Yuan having subsided somewhat of late, one area of the fixed income universe that has caught our attention is Emerging Market Debt (EMD).
Indeed, the relatively attractive income returns available from EMD in a world starved of yield, coupled with attractive relative valuations in relation to developed markets, has made the asset class difficult to ignore. Though this valuation gap has narrowed to a degree YTD (EMD is one of the best performers thus far in 2016), here at MitonOptimal we have been exploring how best to play an asset class that we believe has plenty more upside to offer after having underperformed following a 3-year bear market.
The higher yields available in the emerging world, though attractive, come with heightened levels of risk attached, as the potential for political instability and economic volatility is more substantial than in developed countries. As such, the decision on whether investment in hard or local currency bonds, which can positively or negatively affect the yield on offer, is an important one (or, perhaps most likely, a combination of the two!).
Whether used as a portfolio diversifier, to gain access to a particular market or a source of an income stream, the scarcity of yield in developed markets should prove a continued tail wind, driving inflows into EMD, providing the headwinds referred to above remain absent.Emerging Market Debt - An Opportunity?