EMERGING ON TOP

Emerging Markets Debt (EMD) has been among the top performing fixed income exposures this year. Alongside a more favourable backdrop of resilient growth, moderating inflation and easing monetary policy, we turn our attention to the asset class whose stellar performance has quietly slipped under the radar.

At over 15% returns year to date, Local Currency EMD has been the top performing fixed income asset class this year, led by strong local rates returns (~9%) alongside EM FX gains (~7%). Hard Currency EMD has followed closely, ranking among the strongest performing USD-denominated fixed income sectors this year at nearly 13% returns, amidst positive USD rates returns (~7%) and tightening EM credit spreads (~6%). This has not gone unnoticed by investors, as both exposures have gathered over USD 1 billion in inflows each this year in iShares ETFs alone, a sharp contrast to flows a year ago.

The investable EMD universe can broadly be classified into three areas – local currency, hard currency, and hard currency corporates. Today, the Fed’s pivot towards resuming its easing cycle and a softer USD sees tailwinds for the asset class, including a boost to fundamentals from lower funding costs and improved financial conditions. While each EMD segment is backed by different drivers of return and have distinct use cases, the EMD ETF toolkit allows investors to access all three separately through an efficient ETF vehicle.

Brazilian local bonds in particular stand out with some of the most attractive real yields globally, with the outlook supported by a softer USD backdrop. Brazilian zero-coupon bonds currently yield around 13.6% and have also benefited from FX gains of over 12% YTD, while investors can enjoy capital gains exemption through a tax-efficient ETF vehicle. Moreover, with markets pricing in over 200bps of rate cuts over the next two years, the exposure’s 2 year duration appears well positioned to capture potential tailwinds from an easing monetary cycle.