After a three-year bear market in emerging markets, low-to-negative yields, a continued expansion in the aggregate balance sheets of the larger central banks—Fed, ECB, BoJ, BoE and PBo—as well as improving fundamentals in emerging world, are creating a great migration toward Emerging Market (EM) debt.
With the ‘substantial’ increase in economic, political and institutional uncertainty following the Brexit vote, the IMF has cut their global forecast for 2017 by 0.1 percentage point, to 3.4%. The fallout from the vote remains locally contained however, and the IMF expects growth in emerging markets to accelerate to 4.6% in 2017, from 4.1% this year and 4.0% in 2015. Even had the vote been to remain, the IMF stated they had been prepared to raise the outlook for 2017, “on the back of improved performance in a few big emerging markets, in particular Brazil and Russia.”
While the three key headwinds against EM growth—1) USD strength fueled by monetary policy divergence in developed markets, 2) uncertainties around China’s growth and FX policy, and 3) a sharp decline in commodity prices, are loosing strength. After almost three years of subpar growth, some “green shoots” have appeared in EM economies -specially in China, Brazil and Russia, which were most hit during the recent downturn. Higher commodity prices have provided respite to long-suffering commodity producers; a fundamental healing that reinforces the recovery in asset prices. And although global policy divergence is still on the table, – with a slightly hawkish Fed and Japan going for a modest dose of monetary stimulus, the scarcity of yield has actually been accentuated by the Brexit vote.
Meanwhile, there are still other strong political uncertainties in the developed world that worry investors. Beside the U.S. elections on November 8, and Spain’s inability to define its government, Italy will be conducting a constitutional reform referendum later this year and Germany is scheduled to undergo federal elections in late-summer 2017.
Considering the actual political event risk in developed nations with low or negative yields, investors worldwide are once again looking into EM, making it so portfolio flows may become a key driver of EMD this year.
While local currency debt provides a greater potential for alpha generation, given currency volatility heightens in periods of uncertainty, hard currency EM debt is likely to provide a more stable income stream than local currency counterparts. A pure EM unconstrained strategy that picks from the best opportunities available might be the best option for investors seeking income stability and total return in Emerging Markets debt. Meanwhile, for those looking to maximize the return on their investment through a combination of capital growth and income, an option would be to invest on the BGF EM local currency bond fund. The Fund invests at least 70% of its total assets in fixed income securities denominated in local currencies of developing market countries, including bonds and money market instruments.