5 JUN, 2023
By Hugo Verdiere
By Michael Vander
In the intricate landscape of global investing, emerging market debt stands as a compelling asset class. It's a unique nexus of diversification, yield, and potential returns. However, to harness the full potential of this asset class, active management is key, allowing investors and analysts to go beyond the largest emerging economies, venturing into the less explored smaller markets. These markets are often affected by a so-called ‘information premium’. Frontier markets in particular are often under-covered by analysts, resulting in a lack of readily available information for investors. As a result, two countries with the same credit rating on paper can have vastly different risk profiles in reality. To understand these nuances, investors and analysts need to conduct in-depth research and even travel to these countries for first-hand experience.
Next, investors should consider whether to invest in hard or local currency. Hard currency, including widely accepted currencies like the USD or EUR, is easily convertible and extensively used in international trade. In contrast, the local currency is predominantly used for domestic transactions in a particular country or region. Both hard currency (like the US dollar or Euro) and local currency bonds have their own merits and are subject to different risks. The choice between these two types of bonds depends on an investor's risk tolerance and desired exposure to various market risks.
A clearly-defined ESG approach is also critical in this asset class as good governance and strong macroeconomic performance are interconnected. Emerging markets are increasingly addressing sustainability through specialized financing tools like environmental, social, and sustainable-linked bonds. This is why we rely on our proprietary quantitative sustainability model - based on over 50 criteria - to determine the ESG-profile of countries in which we consider investing. This model, which has been in use for over a decade, already incorporated sustainable development goals before they were pushed by the United Nations.
Over the past decade, emerging markets have evolved significantly. The market size has expanded rapidly, particularly in local currency bonds. Concurrently, there has been marked improvement in institutional quality, supported by increasing technical aid from multilateral institutions. The increased stability and reliability of these markets underline the asset class’s growing attractiveness to investors.
Finally, it’s important to keep in mind that emerging market central banks commenced their tightening cycles ahead of developed market counterparts. In combination with attractive pricing, this makes it a favourable time to invest in emerging markets. Further tailwinds from potential US dollar softening and the reopening of the Chinese economy are expected to deliver a strong year for emerging market debt.
DPAM SA/NV (Degroof Petercam Asset Management SA/NV in full) rue Guimard 18, 1040 Brussels, Belgium l RPM/RPR Brussels l TVA BE 0886 223 276 l. Marketing communication. This is not investment research. Investing incurs risks. Past performances do not guarantee future results.
By Duncan Lamont
By Gillian Edgeworth