Emerging-market local bonds are back in the spotlight, with Pimco seeing “handsome” rewards and Ashmore calling them the best bet in the debt world.
Pacific Investment Management Co. said Monday the local government debt market will become much larger, deeper and more liquid as countries including China and Egypt are likely added to benchmark indexes. This will increase the attractiveness of assets that are already being boosted by a slumping U.S. dollar, one of the reasons Ashmore, BNP Paribas Asset Management and Schroders Plc are positive on developing-nation debt.
Further gains in emerging-market sovereign local bonds would come on top of a 7.4 percent rally since the end of 2016, the strongest start to any year since 2010, when a Bloomberg gauge for the asset class was initiated. Investors’ hunt for yield amid suppressed rates in industrialized nations has boosted the appetite for riskier assets this year, while faster growth in developing nations and stable political backdrops have also lent support.
“Emerging-market local bonds are the cheaper part of global fixed-income market and should outperform,” said Jan Dehn, the head of research at London-based Ashmore Group Plc, whose Emerging Markets Local Currency Bond Fund has beaten 85 percent of its peers in the past year. “Real yields are very high; EM currencies still very cheap.”
Dehn forecasts local notes will return 50 percent over the next five years, with 20 percentage points coming from currency gains and the balance from price appreciation and interest payments. Active portfolio management, he said, could boost these returns.
BNP Paribas’s asset-management unit also recently said gains in emerging-market local bonds can come from the currency side, with the dollar looking overvalued after years of appreciation. (A measure of the U.S. currency’s strength reached the highest level since at least 2002 late last year.) The firm sees little room for emerging-market yields to fall.
Jim Barrineau, the co-head of emerging-markets debt at Schroders in New York, is overweight local bonds from developing nations. He says the firm’s money managers are focusing on higher-yielding countries such as South Africa, Russia, Brazil and Turkey.
“The key driver is the weak U.S. dollar and we don’t see that ending anytime in the near future,” he saidJPMorgan Asset Management says local-currency bonds are the favorite asset class within the emerging-market debt space as they are still undervalued. Diana Amoa, senior portfolio manager, sees opportunity for further currency gains in Poland, Hungary and Czech Republic because of faster economic growth in Europe, while also favoring high-yielding countries like Mexico, Indonesia and Turkey.
Although prospects for higher interest rates in the U.S. could halt the dollar’s slide and post an obstacle for emerging-market bond outperformance, many investors are confident that gradual monetary tightening will avoid a harmful outcome for riskier assets.
Phillip Blackwood, managing director at EM Quest Ltd., which advises Sydbank A/S on $2.7 billion of emerging-market assets, says the Federal Reserve is increasingly taking into account the reaction of financial markets to its policies. Since policy makers are trying to avoid disruptive shocks, he is bullish on local bonds from developing nations.