As the developed world economies transition back towards more ‘normal’ conditions (by which we mean higher interest rates as inflation ticks upwards and the withdrawal of quantitative easing (QE)) many investors are rapidly seeking to adjust their exposures, particularly among fixed income assets as higher interest rates raise the potential for losing money as bond prices fall.
Duration management is seen as key and many are seeing the potential merits in reducing sensitivity to interest rates. Of course, this isn’t a particularly new theme and during the world’s economic recovery there has been ongoing debate about a bubble in bond markets. One option is to increase the emphasis on short-duration assets – a move that reduces risk of capital loss as rates rise but also pretty much means an acceptance of virtually no investment return.
Faced with the latter we felt it wise to seek other options – of course our clients want us to be mindful of their capital but they’re entrusting us with their money to generate a return.
Opportunities in emerging debt
In this context, select pockets of emerging market debt look attractive – they offer higher yields and in contrast to developed markets like the US and UK, which stand at the start of a rate rising cycle. In many emerging markets inflation has (or is) falling and interest rates are on a downward trajectory. Mexico for example has raised rates 12 times since 2015 and looks to be at the peak of its cycle. In Russia, South Africa and Peru the central banks are cutting rates. Whilst not facing the same debt related issues as their counterparts in the developed world, emerging market central bankers have dealt with their own challenges (like commodity price falls); Elvira Nabiullina, was named central banker of the year by several publications in 2015 and 2017 in recognition of her efforts to steer the Russian economy through these challenging times. There are numerous opportunities in the asset class and the potential risk/reward payoff can be compelling. For example, the nominal yield for the emerging markets local currency market (which is 85% investment grade and only five years in duration as a market) is 6.1%, a real yield of 2.8%.