Some of the world’s largest asset managers are finding opportunity in an unexpected corner of the bond market: emerging economies, where higher real yields and stronger fiscal discipline are attracting capital while developed-market government bonds come under pressure.
BlackRock and JPMorgan Asset Management are among the firms increasing their focus on emerging-market debt as investors reassess where the best risk-adjusted returns are available in global fixed income.
The shift comes during a difficult period for government bonds in the United States, United Kingdom, Japan and other major economies.
Long-term yields have climbed as investors worry about persistent inflation, large government deficits, heavy borrowing needs and renewed geopolitical risk.
Japan’s 10-year government bond yield recently reached 3% for the first time since 1996, while U.S. Treasury yields have moved sharply higher and investors are increasingly discussing whether the benchmark 10-year could again approach 5%.
Against that backdrop, some emerging markets suddenly look comparatively attractive.
One reason is simple:
Real yields are high.
Real yield measures how much an investor earns after inflation.
Countries including Brazil and South Africa continue to offer substantially higher inflation-adjusted returns than many developed economies.
That gives investors a larger cushion if global interest rates remain elevated.
BlackRock has already moved local-currency emerging-market debt to an overweight position, reflecting the firm’s view that valuations and income opportunities have become more attractive.
JPMorgan Asset Management has expressed a similar preference, pointing to unusually high real yields available across several local emerging-market bond markets.
The strategy represents a reversal of the way many investors treated emerging markets for much of the previous decade.
For years, U.S. assets benefited from strong economic growth, a powerful dollar and enormous demand for American stocks and bonds.
Emerging markets often struggled with weaker currencies, inflation and political instability.
But the financial landscape has changed.
Many emerging-market central banks raised interest rates earlier and more aggressively than their developed-market counterparts during the recent inflation cycle.
Several countries also strengthened foreign-exchange reserves, improved monetary credibility and developed deeper domestic bond markets.
Those changes have made their economies less dependent on foreign-dollar borrowing than they were during previous crises.
Investor money is following.
Emerging-market debt attracted approximately $214 billion in inflows through July, the strongest pace in roughly two decades.
Bond issuance from emerging economies has also reached record territory.
The appeal has been strengthened by weakness in the U.S. dollar.
When the dollar falls, investors holding bonds denominated in currencies such as the Brazilian real, Mexican peso or South African rand can receive an additional boost when those investments are translated back into dollars.
But the trade is not without substantial risk.
A renewed surge in U.S. interest rates or sharp strengthening of the dollar could quickly reverse capital flows.
Political instability, commodity-price swings and country-specific fiscal problems remain important risks across emerging markets.
And if the Federal Reserve becomes significantly more aggressive about raising rates, higher U.S. yields could once again pull money away from developing economies.
What It Means for You
This is an important change in where some of the world’s largest investors believe value can be found.
For years, the simplest bond strategy was often to buy debt issued by wealthy developed countries and treat emerging markets as the riskier alternative.
That equation is becoming less obvious.
Governments in the United States, Japan and parts of Europe are carrying enormous debt loads while continuing to borrow heavily.
At the same time, several emerging economies have spent years repairing their finances and fighting inflation aggressively.
That means investors can sometimes receive higher yields from countries whose financial fundamentals have actually been improving.
The result is a remarkable reversal:
While investors worry about government borrowing in some of the world’s richest economies, BlackRock and JPMorgan are finding opportunities in countries that markets once considered considerably more dangerous.
That does not mean emerging-market bonds have suddenly become safe.
It means the definition of where the risk is is beginning to change.
And when institutions managing trillions of dollars start shifting money because of that change, global capital flows can move with them.
JBizNews Desk | New York
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