Revisiting EM Hard Currency Debt

Our EM debt portfolio managers discuss the rising relevance of the asset class in institutional portfolios and the implications of a transformational decade

Aug 23, 2021

21 minutes

Werner Gey van Pittius
Thys Louw

The fast view

  • Investors are increasingly reassessing their allocation to emerging market (EM) hard currency debt, one of the few remaining sources of yield in today’s global fixed income markets. In addition to yield, the risk-adjusted return profile and diversification properties of the asset class explain why some institutional investors’ capital market assumptions are pointing toward larger allocations.
  • Although investors have flocked to developed market (DM) credit for yield pick-up, superior fundamentals for comparative credit quality mean EM hard currency debt may improve the yield and return potential of portfolios without introducing excessive risk. Over the past decade, EM fundamentals have strengthened, reinforcing this benefit.
  • The remarkable evolution of the asset class over the past decade has seen the number of markets almost double (now 73) and its regional footprint diversify significantly. The increased importance of smaller, less-liquid high-yield markets has broadened the opportunity set, while introducing new challenges and complexities.
  • The size, diversity and liquidity considerations in the investment universe today make a high-conviction, selective approach essential. At the same time, investors need to be careful to avoid a concentration of portfolio risk, given the potential for negative credit events to erode returns.
  • In the COVID era, the importance of structural reforms in EM has risen; investors should look for managers with the depth and breadth of expertise to identify early those economies that are on the right path and, conversely, those where a structural deterioration is occurring and credit sustainability is under question.
  • The ‘G’ in ESG has always been critical in EM. However, the ‘E’ and the ‘S’ are becoming increasingly important to integrate, introducing additional challenges given the inherent complexity of ESG analysis among EM.
  • With the continued scarcity of yield in fixed income markets, we expect more investors to revisit their EM hard currency debt allocations. Other supportive tailwinds for the asset class include improving trade flows within EM, and we continue to see attractive valuations in high-yield markets where spreads are yet to fully recover.

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Specific risks
Default: There is a risk that the issuers of fixed income investments (e.g. bonds) may not be able to meet interest payments nor repay the money they have borrowed. The worse the credit quality of the issuer, the greater the risk of default and therefore investment loss. Derivatives: The use of derivatives may increase overall risk by magnifying the effect of both gains and losses leading to large changes in value and potentially large financial loss. A counterparty to a derivative transaction may fail to meet its obligations which may also lead to a financial loss. Interest rate: The value of fixed income investments (e.g. bonds) tends to decrease when interest rates rise. Emerging market (inc. China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.

General risks
All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests. If any currency differs from the investor’s home currency, returns may increase or decrease as a result of currency fluctuations. Past performance is not a reliable indicator of future results.

Authored by

Werner Gey van Pittius
Portfolio Manager
Thys Louw
Portfolio Manager

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