Emerging market debt has matured from being a marginal choice in investors’ portfolios to having greater prominence through direct investments or multi-management funds. It has even become a core portfolio investment that now better reflects the size of the emerging debt market.
When all asset classes are included (local and hard-currency government and corporate bonds), the market has doubled from USD 9.3 trillion in 2010 to USD 18.9 trillion in 2018 (vs. USD 1.2 trillion for dollar-denominated high-yield bonds (US HY, based on the ICE – Bank of America Merrill Lynch index). All of this progress justifies taking a new look at investing in emerging debt.
In 2018, the emerging debt market underperformed significantly, mainly due to the US Federal Reserve’s decision to raise its key rates by 100bp and concerns that there was more to come; tensions between the US and China over customs duties; and idiosyncratic risks in countries such as Argentina and Turkey, whose economic fundamentals are still poor, although these risks do not apply market-wide.
Given the above, while investors can expect 2019 to be volatile, the economic environment is unlikely to impede emerging debt performance. After a topsy-turvy 2018 and markets pricing in too much bad news, there should be a gradual, modest improvement in economic growth in a still-favourable interest-rate environment.
After the rally in all risky asset classes so far this year, a conservative stance on the near term would be prudent, but emerging debt valuations still look good. Emerging debt remains under-invested by foreign investors but can offer a more attractive risk-return than emerging equities. The signs are that now is the time to take a new look at emerging debt when considering one’s asset allocation.