After sell-off and China slowdown, investors pile back into emerging market bonds
Plunging commodity prices and a slowdown in China have prompted a sell-off of emerging market bonds over the last two years, but some investors have started to dip their toes back into the beleaguered sector.
Capital flows have turned positive amid a wave of currency depreciation over the last several years, and investors such as Eaton Vance and HSBC Asset Management have added exposure to emerging markets.
The decline in oil prices over the summer of 2014 drove a sell-off in currencies of emerging market energy exporters. Overall, emerging market currencies have depreciated against the US dollar by an average of 30 per cent following their post-financial crisis peak in 2011, according to estimates from HSBC Asset Management.
This depreciation has created opportunities for patient investors willing to scour for bargains.
“We are at that important juncture where currency weakness has become a positive tailwind for emerging market debt,” said Kathleen Gaffney, co-director of diversified fixed income at Eaton Vance in Boston.
The market is not for the faint of heart, though. Some investors are buying with the understanding that there is a big risk that emerging market assets might drop further.
But undervalued bonds denominated in local currency from Brazil, Turkey and Mexico are enticing to some who see value now. Investors are citing high annual returns of up to 15 per cent on some of these securities.
“There’s no free lunch, but at least you’re getting paid for the risk you’re taking,” said Guillermo Ossés, head of global emerging markets debt portfolio management at HSBC Asset Management in New York.
HSBC, which oversees US$135 billion in emerging market assets, picked up local-currency debt positions in Brazil, Mexico, Turkey, South Africa, Indonesia and Colombia over the summer, Ossés said.
The currencies of these countries have deteriorated to levels that have helped improve their trade balances.
The Brazilian real, for example, has depreciated by almost 40 per cent over the past five years, which has reduced the nation’s current account deficit during most of 2015.
For the 12 months ended on September 30, the deficit was equivalent to 4.18 per cent of Brazil’s gross domestic product, down from about 4.4 per cent in the year to May.
Gaffney said Eaton Vance, which has assets of nearly $300 billion under management, added Mexico debt and initiated positions in Brazil and Indonesia. Its bond fund, which has more than $1 billion in assets, now holds a 15 per cent exposure to emerging market debt, she added.
Investors pumped $13.9 billion into emerging markets in October, the sector’s first monthly inflows since June, according to data from the Institute of International Finance global trade group.
Emerging market bonds attracted $7.7 billion in investments overall.
“In many emerging market countries, we’re starting at such a low level that we don’t need a lot of better news for people to get more optimistic,” said Jim Carlen, a Minneapolis-based senior portfolio manager for the emerging markets fixed-income team at Columbia Threadneedle Investments.
Jim Cielinski, Columbia Threadneedle’s global head of fixed income, said the firm, which oversees $471 billion in assets, favored countries moving down the reform path, such as Mexico and India, and those with significant impetus to curb excessive government spending, such as Indonesia.
Emerging market local-currency bonds also had inflows in October, according to Morgan Stanley’s Emerging Market Exposure Index, which showed global funds were overweight on this specific sector.
The same data showed portfolio flows into local currency bonds grew in Latin America this month but decreased in some Asian countries, such as China, Malaysia and the Philippines.
“Differentiation among emerging markets will continue to be the theme,” said HSBC’s Ossés, “as tighter global liquidity conditions and declining commodity prices spell a less-supportive environment and expose differences between weaker and stronger countries.”