Are Emerging Markets Bonds a Once in a Generation Opportunity?
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Walk the money for the rest of us. This is a personal financial on money, how IT works, how to invest IT and how to live without worrying about IT. I'm your host David.

Dying today is episode four seventy four. It's titled our emerging markets bond a once in a generation opportunity. A month of year ago, one of our members of money for the restless plus sent me a strategy piece by the asset manager.

G. M. O. IT was written by Victoria corner. He is on the portfolio, a management team for G. S.

Emerging markets debt funds in the peace, he wrote based on our reading evaluations for emerging markets, and we anticipate looking back at this current period as a generationally attractive entry point for emerging market local debt. Now in this episode are going to take a look at emerging markets of debt. But there is a distinction that SHE made.

There's emerging markets local dead, which is denominated in the local currency of the issuing country, and there is U. S. Dollar denominated emerging markets dead, that the interest in principal needs to be paid in us. dollars.

And as an investor investing in emerging markets U S, dollar denominated that you don't have the currently, you're not heard by the weakening of the emerging markets countries currency nor do you benefit when emerging markets currencies appreciate relative to the U. S. Dollar corner continues. The U. S.

Dollar overvaluation is at relatively extreme levels, likely to provide a strong ongoing tail win for non dollar assets in we believe emerging market local debt can be a powerful way to capitalize on this as a supplement to both emerging markets equities and other asset classes. In another piece SHE wrote that was published in the financial times that are linked to gmo, estimates that the us dollar is eight to fifteen percent over values verses the currency baskets that make up emerging markets local debt and emerging markets equities. SHE concludes in her peace.

We believe that for relative value diversity and potential alpha reasons now for being excess returns, emerging markets local debt deserves a prominent place in porta folios today. If you like me, when you think you have emerging markets debt, first word that comes to mind is default. Fitch to the rating agency pointed out last year that there had been fifteen separate default events for emerging markets bonds since twenty twenty, and that's across nine different countries.

That compares nineteen default across thirteen countries between the two thousand and twenty nineteen because of the pandemic as well as rising government and deadness as a result to responding to the pandemic and just social programs. Another government spending that has made to continue default for emerging markets bonds. Fish points out that currently there are five emerging markets countries in default on their debt, belarus, lebanon, ana sancha in zambia, some of the other defaulted countries, such as all argentina, have have worked to restructure their dead in.

And often times when a country default, we'll work with the international monetary fund to get some funding and restructure that dead and bian large, the type of dead they were talking about be a local currency dead or use dollar dynamic and that this is that issued by governments the the vast majority of emerging markets debt is sovereign bt rather than corporate debt. So IT would appear then that emerging market bonds is is going through a chAllenging environment with with these default. Yet if we look at the returns, the U.

S, dollar, ominous emerging markets bond T S and performance of active fund managers in the emerging market dead space, they have all formed the U. S. Bond market as measured by the bloomer U.

S. Aggregate bond dex. They ve up performed for the past year, three years, five years and ten years. Over the past decade, the I share J, P, Morgan U, S, dollar energy markets bond T, F has returned two point four percent analyzed compared to one point four percent analyzed for the bloomberg U S, aggregate bond index.

The double emerging markets fixed in income fund has returned three percent analyzed over the past decade, compared IT again to one point four percent for the bloomer U, S, aggregate bond index. Those funds I mentioned, our U, S, dollar denominated emerging markets debt fund, the local currency version has not outperformed the bond market. For example, of the I shares J P Morgan merging markets, local currency body T F returned negative one point seven percent analyzed for the past decade ending April eighth twenty twenty four.

And so IT IT did LG. The main reason IT trailed was because emerging markets currencies have weakened over the past decade. There's been a negative six point two percent analyze drag for emerging markets like currencies relative to the U.

S. Dollars and for emerging europe. And middle is it's also been at six percent analyzed drag. So that would have reduced the return by six percentage points per year.

Just do the currencies even though the yields on local currency merging markets dead would would have been much higher than develop markets bonds. Now analysts at gmo and and others believe that there's been a change to what's going on with emerging markets. Even then, they have out perform. They think they're gonna even Better. Cory rates that is, is difficult to spot inflection point, particularly when we think about the non stop dollar strength, taking a position against the dollar right now to say that I will stop appreciating relative to other currency, not not just taking that position when investing in local currency, merging markets dead, but just investing in non U S. Stock example on the basis that somewhat concerning saying that, well, U S.

Dollar isn't going to continue to strengthen relative to the rest of the world, cory, right? The key question is, can the USB even more exceptional than IT is now to continue the dollars upward trend, the glass half empty french woman in me believes geopolitical risks, the russian ukraine war, middle east conflict, china, taiwan n tensions and a low growth environment in most places outside U. S.

Might signal that we have not yet reached such an inflection point. There are many reasons to stay invested in the U. S. And not venture out to other areas, either stocks or bonds.

Cormac continues, in a word of risk aversion, the dollar can indeed remain king, the glass half of american and me, he continues, sees factors such as sluggish growth and a lack of structure reforms in recent years already Priced into non U. S. currencies.

In other words, investors are now more highly compensated for the risks associated with emerging market currencies, and they have been for more than a decade. And that's a key when IT comes to investing. Are we being compensated for the risk in terms of the potential return? Is the asa class cheaper or the yields high enough on bonds to competition for that risk? Are the divided yields high enough and evaluations low enough as reflected by Price to earnings ratios sufficient to competition for risk on the equity side?

That's one reason we launched asset camp so that we can look at those factors have watched the compensation by now as a campus focused on stocks, and we just released a major update for as a camp with additional tools, additional charge to to help answer these questions. And and we're working on the bones at that acid camp, but I will be compensated for the risk taking. Read another report by an alu sharma he was writing for the financial times, and he point IT out that there are some emerging world powerhouses such as india and indonesia.

He realized, and I I saw this on at a camp at the twenty year, analyzed returns, ranking the forty six stock indices that we cover. The best performing index over the past two decades was india. And because the economy is growing faster, they've been more disciplined in terms of government finances.

And sharma points out that india and indonesia are recognized that they're in solid shape and they've been successful and navigating the economic chAllenges, including the pandemic. But he says that other countries are now forming, including turkey, argentina, egypt, nigerian in kenya. Those five countries are large countries make up there in the top forty of emerging economies.

And even though they've had high inflation and high debt deficits, the market is forcing them in. Politics are forcing them to be more disciplined. They've been new leadership brought in on some of those countries with the Mandate to reform, to bring down the deficit, to bring down inflation, to bring down interest rates.

Because when investors get spoke, money flows out of the country, but when things become more attractive and A C reform, capital flows in to those countries in that can strengthened in the currency, relativist dollar and other developed currencies. So I I read a number reports that suggest there are emerging markets countries that are reforming. And the risk, I est emerging markets countries have actually seen the best performance of late.

The incremental yield for relative to treasury bonds. For some saharan africa, emerging markets debt has gone from over ten percent in may twenty twenty three down to around just over six percent today. Valentina chan, who is ahead of emerging markets at investment firm macae shields in london, says there's seen great value in single and triple sea emerging market dead credits for argentina, egypt in kenya that the risky segment of the market, triple sea U.

S. Dollar to nominate emerging market bonds have returned sixteen percent year to date. That's something to consider that when we talk about emerging market funds, by and large, these are non investment.

great. They are risky. And so you get higher yields with emerging market sponge, but you can also get currency weakness if things aren't going well.

And that's what brought down the returns in the negative territory over the past decade for emerging markets local currency debt. Now what are those yellow today? As we look at the universe, if we look at emerging markets U S. Dollar bonds, an example would be the I shares, jp moran, U S. Dollar emerging markets bond, tf tickers, emb in a how make sure in the showing tes will list out the ticker symbols and the names for any of the investments that we've mentioned today.

But if we look at emerging markets dollar bonds, if data going back to nineteen ninety six, this is data from bloomberg IT returned seven point three percent, analyzed the index, the average yield to maturity going back to one thousand hundred and ninety six has been seven point four percent, the current spread er incremental yield for U. S. Dollar emerging markets bonds is three percent right now.

The long term average has been four percent historically. When I have analyzed emerging mark bonds, i've been most come to one investing when the spread is greater than average. It's not now.

And we talk about a generation of opportunity cormet from gmos focused on local currency emerging markets dead, but U. S. Dollar denominated emerging markets death.

The spread is not wider than average and just the average duration ation or interest rate sensitivity is around six years. So that's the U. S. Dollar denominated the debt. If we look at the emerging markets local currency bond etf by eyes shares takers, L M, B, we've mention the returns of a negative.

Negative one point six percent analyzed over the last decade, negative two percent analyzed over the past five years, and negative three and a half percent over the past three years. It's sa seized, which would be its ultimatum. Ity less fees is just around seven percent. This is where I found a discrepancy. We subscribe to bloomberg fixed income data, and that's what were you using to build out the bond side of asset campus.

We also use the information on money for the rest of us, plus there's the bloomberg local currency, emerging markets debt index is government debt IT says the ultimatum ity on that is four percent and yet if we look at the eh J P Morgan emerging market local mercy bond T F if I look at a similar etf by state street there showing yield is uh seven percent and and we at this index is saying four percent, I have an email into a blimber's PS sort of figure out what's going on here. What I believe is the issue is that china has been added was added to the emerging markets debt, local currency indexes back in, and interest rates on on chinese government dad is are fairly low. The tenured yield on china government bonds is two point three percent compared to something like mexico, where the ten year boniest is nine point six percent.

So depending on how much is allocated to china in an emerging markets and debt fund or the index that will determine the yield. But if it's odd to me that the the maturity, at least on the day that they we're getting from bloomberg is so much low and and IT has been and to so there's something going on there. We're not investing in indexes.

We're not investing in etf. So the sec of the issue, J P Morgan emerging market local currency bond T F is seven percent. Now if we look at the U S, dollar denominated version versus the local currency y version, there is some some difference in composition.

Credit quality for the U. S, dollar denominated version is actually lower at double b plus, where it's triple b for the local currency version. So E, M B is double b plus, the lower credit quality, essentially high yield, non investment grade, where the local currently version is triple be.

And I the difference there is china. Again, the biggest holding in the local currency version is china at fifteen percent, follow by mexico at seven percent, indonesia at seven percent. So more highly rated emerging markets countries, if we look at the local currency version, the top holding is turkey at four point three percent, followed by sadi ababa at four percent, brazil at three point six percent, mexico at three point four percent.

So the dollar denominated version of these fines have obviously less currency risk, but more credit risk. Both these etf have over six hundred bombs. Those are two examples based on just different credit qualities, comparing local currency versus U.

S. dollar. Before we continue limit, pause and share some words from this week sponsors, how do we invest that? Well, we can do etf like we've just mention E M B N, E M B L. We could invest in an active mutual funds.

One of the points the G M O mentioned is that looking at investigate data that IT shows that the median emerging markets dead active manager has outperformed a comparable eat T, S. And indexes. So there is a case, and I have generally invested in emerging markets through active funds, although we did have E M B in our money for the restless plus moo portfolios a number of years ago.

But now emerging markets bond exposure is coming through double line in this monopoly folio examples. So our choices, E T S, we can do active metro funds, but there's also closed and fun that we can invest in, for example. And looking at what's available in the close and fund space, there's the Morgan standing emerging markets debt fund, msd close and funds use leverage.

They are more value than act mutual fantasy T S, because their Price can disconnect from the net acid value. And that fund has the distribution rate of over ten percent. The Morgan stanly emerging markets domestic debt fund. So this would be the local current version, E D D.

It's selling out of four teen percent discount to its net asset value and its distribution rate is seven point seven percent in the showers to this episode, link to a guide on investing in closed and funds because they're unique. And we also have a course that you can get access to on closed and funds through being a member of money for the rest of plus. Or you can buy the course recent, but check out the guide first.

But we can best be a closed end funds and we can have as via act of mutual und. So the double line emerging markets fixed income fined. I've mentioned there is the dub line low duration emerging markets fix in come fund.

There is a virtual ones harbor emerging markets death fund. All these funds have had very similar ten year returns. In fact, the active mutual funds and the etf at similar ten year returns, the Morgan Stanley ging mark dead fun, it's done a little Better at three and a half percent annualized.

I'd be the us dollar version. So those are the vehicles that we can invest in. We need to decide whether we want a local currency version or us dollar denominated version.

By going with the local currency version, you will benefit if the dollar weakens related to emerging market currencies or be hurt. If it's strange. We need to decide whether we want to go active or passive.

And now we want to understand the characteristics of the fund. How much diversification is there? What is the credit quality?

What's the expense if it's a closed and funds, what how much leverage is being used? All the things that we talk about in analyzing and investment vehicles. We look at my portfolio, about seven percent.

My bond portfolio is emerging markets bonds, and it's primarily coming through the w line income fund D. S. L. So this is a closed and fund.

I held IT from twenty thirteen to twenty eighteen, but after two very strong years, was up thirty percent twenty sixteen, sixteen percent twenty seventeen. I sold IT when it's discount in that asset. Vio narrowed and I dissolve.

Investment conditions deteriorated lowly, and I just wasn't come to with the risk of the fun. So I sold IT. But then I bought back in december twenty twenty, then I was selling at a percent discount to its net acid value and the fund is forty percent emerging markets.

Now it's a close in fun, so it's risky. So in my holding period since december twenty, twenty has been a thirty four percent maximum drawed down, but it's returned around eleven percent analyzed since december twenty twenty. And so that's i'm getting exposure, but it's not a big position.

So maybe I should consider increasing my allocation to emerging market bonds. Is IT really once in a generation opportunity, we're looking at yields of six to seven percent and parities, huh? That's not real great.

When I can learn five percent on cash would really to benefit would want the boost from the strengthening currency. And I and I have other investments that benefit from that, mostly on the emerging markets equity side. And I am very much over wait emerging markets relative to the the global stock market.

And there is a part of me that with emerging marked, so what is the next crisis coming along? And yet here we have emerging markets bond to actually outperform they developed markets. Bond space investors have been adequately compensated with higher yields investing in emerging mark bonds.

And if IT could be done through an active manager that hopefully can get out or avoid some of the potential default ts, given there have been dozens of defaults over the past few decades. Yet even with that, they have done Better. That's why I prefer active manager.

I would prefer if the spreads were wider than average, but they are not. And maybe we want to ever go back to that, excepting a period of a huge crisis. And when I added double line, the double line income solution is fun.

In december twenty twenty, we did have above average emerging markets bond reads relative to government bonds. Not why I added IT then that not we're at today yet. We have analysts like those A G M O thing.

Well, because the dollar is so strong to to merging marked countries and the yields are still attractive at seven percent that, that combination of weak emerging market currencies by attractive yields makes for an attractive entry point. We'll see how that works out, but that's our discussion this week on investing in emerging markets bonds. That episode four seventy four, thanks for listening.

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