Rethinking risk in emerging market debt

For risk-averse fixed income investors, there might be nothing so negative as the trend toward negative yields. A potential workaround might be found in emerging markets.

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At the end of August, negative-yielding debt worldwide was about $17 trillion. At that time, Richard Lawrence, senior vice-president of global fixed income at Brandywine Global Investment Management in Philadelphia, Pa., ranked markets by real yield and found that more markets had negative yields than positive.

However, there was one exception: emerging markets.

“While all of the headlines have focused on Europe and Japan and Treasury yields coming down a lot, […] there are still some interesting opportunities in emerging markets,” where yields are about 2% to 4%, said Lawrence in an Oct. 16 interview. His firm manages the Renaissance Global Bond Private Pool and the Renaissance Global Bond Fund.

Emerging markets aren’t inherently risky as some investors think, he said. In fact, U.S. Treasurys could be seen as risky, considering U.S. 10-year real yields — which take inflation into account — hit negative values in late August; they’ve since risen. German 10-year bunds at one point in August yielded -0.75%, though they’re now closer to -0.25%.

In such a market, it doesn’t take a lot of good news to see bond yields move significantly higher, Lawrence said in mid October.

Diminishing macro risk is also helping to make emerging markets attractive, with an eventual trade deal between the U.S. and China improving investor sentiment. “That should be good for China and, ergo, good for emerging markets,” Lawrence said.

Leading economic indicators are also positive. While indicators for developed markets are trending downward, those for emerging markets have bottomed and are reverting to the mean, Lawrence said.

However, macroeconomic fundamentals are more attractive in some emerging markets than others. “We are not taking a scattershot approach,” Lawrence said.

He likes sovereign bonds in Mexico (10-year yields well over 6%), Brazil (also well over 6%) and Indonesia (about 7%). Other examples are Colombia, Malaysia and, to a lesser extent, South Africa.

“You can prudently build small positions in these very attractive markets,” Lawrence said. “The economic fundamentals look intact.” Further, “Policy risk […] is diminishing, not moving higher.”

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Suzanne Yar Khan

Suzanne has worked with the Advisor.ca team since 2012. She was a staff editor until 2017 and has since worked as a freelance financial editor and reporter.