The rise of Emerging Markets: a blended approach to emerging market debt
Valuations in emerging market debt continue to be attractive relative to developed markets, and global monetary conditions remain supportive, says Aberdeen in a new white paper ‘The Rise of Emerging Markets’.
- Emerging market governments are well-supported by falling net external debt levels and hefty foreign reserves.
- Currencies are low and offer value
- Macro divergence across and within the three EM regions remains and this is likely to persist. As such, selectivity will be crucial
- Macroeconomic risks remain, notably from geopolitical influences and China’s recent economic slowdown, but are not confined to emerging markets
Emerging market governments are well-supported by falling net external debt levels and hefty foreign reserves, which is also beneficial for emerging market currencies. Em erging market currencies have seen a dramatic re-rating and hit the bottom of their 20-year range at the start of this year. Ultimately, currencies should stabilise and local currency bonds should become a better-performing asset class in the coming years.
The report says there is still macro divergence across and within the three EM regions and this is likely to persist. As such, country selection will continue to be a key driver of outperformance for emerging-markets debt investors going forward. Overall current account balances should remain reasonably strong, although further capital outflows will likely weigh on currency reserves.
Aberdeen believes commodity prices will remain subdued relative to recent years. Oil and copper are particularly vulnerable in the current environment, and this, along with rising US Treasury yields and the US dollar continuing to weigh on EM currencies, could make it hard for many investors to see past the likely short-term pain. However, separating long-term structural factors from short-term cyclical effects is crucial.
Macroeconomic risks remain, notably from geopolitical influences and China’s recent economic slowdown. However, the current default rate for EM sovereign debt is very low. For a long period of time, investors believed that EM were poorly managed, politically and economically, compared to their developed counterparts. However, this is no longer explicitly the case and sovereign debt, for example, spans a wide spectrum of risks and returns.
The headwinds in emerging market debt been known for a long time and market prices have adjusted. Aberdeen argues that this now makes valuations in EM debt look very interesting after a volatile three- to four-year period. With yields having risen relative to developed markets, and currencies having depreciated, the conditions for outperformance at some point are substantial. It’s just a matter of when that time will come.