GLOBAL - Emerging market debt remains attractive in comparison to G7 government bonds despite inflationary concerns and unrest in the Middle East, Aberdeen Asset Management believes.
The firm said emerging economies are generally healthier and less indebted than developed countries, with the average debt to GDP levels for emerging markets forecast to be 35% of GDP by 2013, compared with 119% for advanced economies.
"One need only consider the impact of the global financial crisis of 2008-09 on developed economies such as Iceland and the Greek and Irish sovereign debt crises of 2010 to understand that many emerging market economies are in a much stronger position than some developed markets," Aberdeen head of emerging market debt Brett Diment (pictured) said.
Furthermore, emerging markets are currently growing much more rapidly than developed countries, he added. According to IMF statistics, as a whole their GDP growth is trending over 6% a year on average compared with around 2.5% in developed countries.
However, despite growing recognition as an asset class, emerging market debt is often misunderstood, Aberdeen believes. It said many investors continue to focus purely on US dollar denominated emerging market bonds, overlooking the opportunities available in local currency and credit markets.
"Given that the outlook for hard currency debt is mixed, with the 6% yield on the hard currency sovereign index looking less appealing in a period of rising US Treasury yields, investors need to dig deeper and seek diversification," Diment said.
"Emerging market local currency debt has exposure to currency and interest rate dynamics and the investor base, and offers broad geographical diversification as well as being a natural hedge against US dollar weakness."
Emerging market corporate debt offers further diversification away from hard currency sovereigns, with the attraction of higher yields and shorter duration which should provide some insulation in an environment of rising US Treasury yields, Diment added.
Emerging markets now account for 20% of the global corporate bond market and consequently should no longer be overlooked in a diversified credit portfolio, he argued. In addition, some emerging market corporates are characterised by better fundamentals than their counterparts in developed markets but still trade on a higher yield.
"Assessing the broader opportunity set, we think local currency debt offers the best return opportunities, with the index yield now above 7%," said Diment. "Investors can also benefit from structural currency appreciation in emerging markets, despite efforts by policy makers to stem the strength of their respective currencies.
"Local currency debt may offer less appeal over the short term, during a period of rising inflation and lax monetary policies, but as inflation pressures ease, it will be poised to outperform global fixed income assets. We are also optimistic about many emerging market corporates which are attractive compared to both emerging market government bonds and developed market credits."
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