GLOBAL - Local currency emerging market debt (EMD) will continue to outperform other asset classes as few others can offer comparable returns from income, capital gains and FX appreciation, Baring Asset Management believes.
With EM countries now at differing stages of their economic cycle, and inflation causing some concern for a number of central banks, Barings said investors should take a scenario-based top down approach to EMD investing.
Thanasis Petronikolos, manager of the Baring Emerging Markets Debt Local Currency fund, said: "In our view, local currency emerging market debt offers some of the most attractive risk -adjusted returns. Indeed, the demand for emerging market debt continues to increase as OECD-based pension funds and domestic EM pension funds build on their currently limited exposure. However, we have witnessed recent volatility in the EMD market caused by geopolitical tensions in the Middle East and Africa and some profit taking after a strong rally in December."
In spite of some volatility, higher productivity growth rates and better demographics are reflected in the strong growth potential for emerging markets, especially when compared with developed markets, Petronikolos continued. As long as investors continue to search for yields in the current ultra-low interest rate environment, the case for emerging market debt will remain strong, as coupon yields are attractive at around 6%, he added.
The Baring Emerging Markets Debt Local Currency fund retains an overweight allocation to emerging Europe, made up of exposure to Hungary and Poland. In Latin America, the manager favours the Mexican bond market in terms of both bonds and currency after the bank of Mexico retained its benchmark interest rate of 4.5%, extending its longest ever interest rate pause.
"Within emerging market debt we believe the greatest opportunities lie within local currency because of the opportunities for income and capital gains as well as FX appreciation," Petronikolos said. "Local debt currently accounts for 80% of the total $6trn EM debt universe and within this it is expected that the share of emerging local sovereign and corporate debt will rise.
"Although EMD remains subject to global economic volatility, the resilience of this asset class has been proven after several financial crises including that of 2008. The inclusion of EM local debt can improve the return/risk profile of both global bond and balanced portfolios as modest correlations with developed asset classes provide diversification benefits."
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