The investment case both for and against emerging markets is a familiar one. Intermediaries are well aware that clients with emerging market exposure are vulnerable to the risk of capital losses, but also stand to profit from access to some of the world’s high-growth economies.
Both equities and bonds in these markets have been touted as wire bets in 2019, but this is yet to translate into renewed investor appetite. In the 12 months to the end of March, retail investors put just £8m into the Investment Association’s Global Emerging Markets sector on a net basis.
Emerging market debt is more of a niche proposition than its equity equivalent: the IA Global Emerging Markets Bond sector had £8.4bn in assets at the end of March compared with £26bn in the equity grouping. The former also has much less in the way of assets than other fixed income sectors.
There are good reasons for this. Emerging market bonds are less high-octane than stocks in the same region, but do tend to be riskier than other forms of fixed income given the instability of some of the companies and countries issuing debt. Intermediaries need not look far for an emerging market crisis: last year both Turkey and Argentina saw their currencies tumble because of wider economic troubles.
Investors have certainly not given EMD their overwhelming support in recent times: in the year to the end of March, the Global Emerging Markets Bond sector suffered net retail outflows to the tune of £65m.
But the rewards of backing these bonds can be significant for courageous investors: EMD typically offers much higher yields than other fixed income instruments, and has outperformed other parts of that universe when it comes to total returns, too.
A look at IA sector performance illustrates this point. A typical fund in the IA Global Emerging Markets Bond sector has returned 19.5 per cent over three years, beating its IA Sterling Corporate Bond, High Yield, Strategic Bond and UK Gilts equivalents. Over five years, the EMD cohort also had a higher average return than each of those peer groups bar UK Gilts.
Getting picky
Attractive as the returns look on paper, the volatility of this asset class means performance can vary extensively across different funds and regions. Given the high levels of risk and reward involved, picking the products best positioned to navigate this investment universe is especially important.
Table 1 shows the IA Global Emerging Markets Bond funds that performed best over the past five years. It might not be immediately obvious what has driven their strong performance, but a closer look at the funds suggests many do share at least one important common trait. This relates to currency exposure.
Last year’s developments in Turkey and Argentina show that emerging market currencies can fluctuate significantly versus their peers in developed markets, thereby distorting investor returns. But fund managers can decide whether to buy EMD issued in the local currency, or choose those instruments issued in US dollars or another developed market currency.
