Summary
The current landscape presents an opportune moment to reconsider the role of Emerging Markets Debt in portfolio allocation, with high nominal yields and expected rate cuts from the Federal Reserve.
Key Points
We believe Emerging Markets Debt (EMD) should serve as a core allocation in investors’ portfolios. The asset class has traditionally been perceived as a tactical investment opportunity or as an off-benchmark allocation. Instead, we believe a favourable macroeconomic outlook, the growth and transformation of the universe and the diversification benefits it offers means EMD should be a core allocation in investors’ portfolios.
From a macro standpoint, EM countries account for over half of global GDP and they should lead the next recovery as Developed Markets (DM) face a slowdown. These economies have matured over the last three decades and, in recent years, strong growth, improving macro fundamentals and orthodoxy in monetary policy coupled with shifting supply chains have led to a re-rating in their risk profiles.
The EM bond universe has also evolved accordingly given its growing market size, the increasing number of issuers, and the growing green, social, sustainable and sustainability-linked bond market, thereby offering investors a composite asset class with greater liquidity and transparency.
The asset class provides attractive yields, a compelling risk-return profile and a diversified income source compared to traditional fixed income, with the potential for growth from a wide range of regions, countries and companies that exhibit lower correlation to global equities and bonds.
That said, EMD represents not only a plethora of opportunities but also some challenges due to the “work in progress” nature of these economies. The differences between EMs are greater than their similarities; that is why we believe extensive research to identify each country’s economic cycle and solvency risk makes the difference when constructing EMD portfolios.
With a long-term perspective, we believe the current environment offers a supportive backdrop for rethinking the role of EMD in an overall asset allocation. High nominal yields and expectations of rate cuts from the Federal Reserve can offer attractive entry points, especially for active managers who can flexibly navigate the complexity of the universe and the geopolitical realignment that is underway, as well as differentiate between the winners and the losers.
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