While Credit Suisse’s Gadsby is constructive on both, though he has put more money into local currency bonds on the back of their strong underperformance last year, Van de Ven shies away from local currency because of the currency risk that is a big return driver, for good and bad.
According to Invesco’s Rahman, however, local currency looks comparatively attractive, and not only because the asset class is growing quickly, which improves liquidity, and offers higher yields. “After last year’s sell-off, EM currency exchange rates are back at the levels of 2004, on average. They have gone back to competitive levels, and there is no fundamental basis for them to depreciate by another 20 or 30%,” he says.
Another factor to speak for local currency debt is the fact that the asset class is less correlated to developed market fixed income and Fed rate hikes than hard currency bonds.
However, all emerging market debt remains highly vulnerable to shifts in sentiment. This is testified by the sheer size of inflows to and outflows relative to its still modest size. More than for any other asset class, flows have the capacity to drive returns in emerging market debt.
A different rationale
“From 2010 onwards we experienced a similar wave of interest based on a perceived improvement in macro fundamentals,” recalls Rahman. “Post-2012, we saw a deterioration in those fundamentals and flows slowed or reversed.” And investors who did not pull out their money lost a lot of it in many cases.
This time around, the inflows are not so much underpinned by EM fundamentals. “Rather, they are predicated on low yields in developed markets. Fundamentals in EM are not really improving,” he says. Therefore, as long as developed market yields stay as low as they are, flows into EMD are unlikely to halt.
Wealth manager Van de Ven confirms the yield on offer is the reason he is interested in the asset class. “We don’t invest in EM because it’s EM, but to offer an alternative to clients to get some yield,” he says.
