Investing in emerging markets in the current landscape

Author: Flavio Carpenzano, Fixed income investment director

Even if the Fed cuts rates, emerging markets are likely to continue to have to navigate a fairly strong US dollar, weak global growth and a tight global election calendar. We see the biggest opportunities in local currency core debt and hard currency frontier debt.

We currently support holding some local duration in countries where inflationary pressures continue to ease and monetary policies become more accommodative. Many of these are in Latin America, including Brazil and Mexico, but we also like duration in South Africa, where real rates are near the high end of historical ranges and still have some cushion against US Treasuries.

Asian central banks are likely to start lowering rates later than the rest of emerging markets and Asian local currency debt tends to be more correlated to global markets, but we see duration opportunities in China, Indonesia and South Korea. In China, low yields seem to be justified by stubbornly low inflation and growth challenges. Meanwhile, monetary policy appears tight in both Indonesia and South Korea, especially after Indonesia's surprise rate hike in October. We remain cautious in Central Europe. Inflation seems to have picked up (though unlikely to return to target) and growth has been sluggish, but these trends are reflected in local yields, with aggressive easing cycles discounted in bonds. Within hard currency debt, spreads are fairly tight in the major emerging economies, but if a US recession occurs, dollar duration should offset the impact of widening spreads on yields. These holdings also offer diversification advantages. Examples of higher rated credit in which we have conviction are Korea and Mexico.

We also found value in some dollar-denominated corporate debt issuers. Emerging market companies' fundamentals appear to be in better health, as their treasury managers have mostly adopted a more prudent approach to borrowing. The geographical representation and risk structure of emerging market companies is quite different from that of sovereigns, thus providing an element of diversification. Shorter term investment grade bonds within the corporate world have proven to be quite resilient in times of volatility and can help with defensive positioning.