Over the past few months you may have heard us banging the drum for emerging markets debt (EMD). Why? Very simply, in February we took the structural view that after a three-year bear market, EMD had finally turned the corner.
The drags that prevented investors from capturing the full coupon offered by EMD – the mighty US dollar, sharply falling commodity prices, instability in China’s growth and currency, and a need for EM external rebalancing – have finally abated.
We do not see a return of these headwinds because of Brexit. We now think it’s time to join this ‘great migration’:
- EM debt looks well positioned to receive large inflows of money fleeing low-to-negative rates in developed markets as major central banks turn even more dovish post Brexit.
- EM economic growth finally shows signs of improving and external balances are much stronger after three years of adjustment. This improvement in fundamentals is likely to survive global financial market jitters, provided China’s growth stays on course, and oil prices stabilise around $45-$50 per barrel. We see good chances of both happening.
- We see local currency debt providing greater potential for alpha and capital appreciation. Yet the ride might be volatile as EM FX is the most sensitive to risk aversion shocks. Hard currency debt is likely to provide a more stable income stream than local currency counterparts.
- Investors seeking income stability and total return across hard and local currency debt could opt for an unconstrained EM strategy.
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