The importance of emerging markets in fixed income portfolios

Key takeaways

• The newly elected US President Joe Biden is expected to be positive for both sovereign and corporate debt markets, as there should be less risk of trade wars and better relations with China, which will benefit all of EM.
• In terms of ongoing COVID-19 impact, the demographic composition of most emerging markets is generally more favourable than DM, reflecting younger populations.
• EM by nature can be volatile, and there are always multiple risks, including geopolitics and the risk of the COVID pandemic worsening or mutating. In addition, as technology and innovation come to the market in a variety of sectors, it will be crucial for EM corporates to keep up with the advancements to remain competitive.
• Generally, EM companies are adaptable, and they have lower leverage than DM peers, meaning they can weather upheaval more successfully. There have been fewer corporate defaults in EM than DM, reflecting their resilience.
• EM corporates also benefit from the ‘post-code premium’, whereby very healthy and strong companies that have low dividend yields in DM pay out more interest in EM purely because of the country they are domiciled in.
• China’s recent inclusion into major bond indices is an exciting step for EM debt. China is not a typical EM. It is highly rated, shows low volatility in foreign exchange markets and acts as a great diversifier from DM bonds, as well as yielding around 3%, which is especially appealing for a bond market that is less volatile than many in DM.
• We believe ESG factors are crucial when considering investment decisions in EM debt, and regard positive ESG scores as key to development and growth for both sovereign and corporate markets. To improve the global ESG picture, it will be beneficial for investors to engage and invest with governments and corporates across EMs, which comprise the majority of the world’s population. We believe that an EM or frontier country that is addressing corruption as well as protecting the environment, for example, should be rewarded.
• We are living in extraordinary times from a monetary policy perspective, and we will likely have low interest rates for a while to come. This is very positive for EM, as the yield offered is needed in an income starved world.