Fixed income markets endured a torrid 2022, with both government and developed market corporate bond markets enduring falls far sharper than those of equities.
And within that emerging market bonds suffered to an even greater extent, but with markets having rallied in 2023, many investors are generally more positive on risk assets and are grappling with the dilemma of how to get a worthwhile yield for income-focused clients in a world where inflation remains at double digit levels.
Emerging market bonds had strong inflows in January as many investors reassessed the asset class.
The macro backdrop may also be more favourable to emerging markets as a whole, with dollar weakness and the re-opening of the Chinese economy possibly improving the ability of emerging market companies and countries to repay their debt.
Conversely, the stout rise in yields of developed market government and investment-grade bonds may mean investors no longer need to go out as far on the risk curve as emerging market debt.
Denise Simon, managing director and portfolio manager, emerging markets debt, for Lazard Asset Management, says investors may tend to view fixed income assets generally as a form of protection from volatility in a portfolio, but when it comes to emerging market debt this is firmly in what she calls the “return seeking” part of the portfolio.
By that she means it does not do the job traditionally associated with bonds in a portfolio as volatility is higher, but also that, in common with other highly volatile asset classes, emerging market bonds role in a portfolio is closer to that of equities, as the focus is on generating a return.
She says: “The main benefits are higher levels of income, potential for capital appreciation, and diversification. Thus, we believe emerging market debt should be included in the strategic allocation in a well-diversified portfolio.
"Emerging market debt suffered record outflows in 2022, so many investors are currently under-invested, but we’ve seen flows turn positive recently and expect this trajectory to accelerate as investors come to realise the current opportunity in emerging market debt and once again recognise the benefits of a strategic allocation.”
Tom Kynge, portfolio analyst at Sarasin and Partners, says he is now finding emerging market bonds to be more interesting, but that there are two considerations when choosing how to access the asset class.
The first is whether to invest in local currency debt (that is, get paid your coupon in the currency of the issuer and then exchange it into sterling) or stick to 'hard currency' bonds, that is, those which will repay the coupon, usually in dollars or Euros.
The buyer of the bond is taking the risk with a local currency that it devalues relative to sterling and so the returns on the bond could be less than the loss on the currency.
