Where to find higher real yields

Investors in search of higher real yields should consider a global approach.

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“At any given point in time, there’s massive dispersion in real yields around the world,” says Richard Lawrence, senior vice-president, portfolio management, at Brandywine Global Investment Management in Philadelphia, Pa.

In a late April interview, he noted there were about 850 basis points of dispersion “between the highest and lowest real yield in markets in our universe.”

As a result, “We’re favouring emerging markets,” he says. “That’s where real yields are very attractive.”

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Synchronized global growth is a big reason why. “Emerging markets have been through the healing process,” says Lawrence, whose firm manages the Renaissance Global Bond Private Pool. “Real yields are anywhere from 2[%] to 7%, depending on the market.”

Further, emerging markets exhibit improving fiscal situations. “When you look at IMF forecasts of debt-to-GDP ratios over the next five years or so, they’re forecasted to significantly improve in most markets around the world,” says Lawrence. (In its latest world economics outlook, the IMF forecasts emerging markets growth of 4.6% in 2018 and 5.1% in 2019, stabilizing at 5% over the medium term.)

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In the U.S., however, “we might see the change in debt-to-GDP ratio go the other way,” says Lawrence, because of significant U.S. fiscal stimulus. “If we don’t follow that with gangbusters growth, that’s going to put some pressure on the U.S.’s fiscal picture. It’s probably one of the reasons why the dollar has been in an extended weakening trend.”

In developed markets, real yields—which are starting to tick upward—are unattractive because nominal yields are relatively low, he adds. Also, “we’re finally getting a little bit of inflation pressure in developed markets, and that’s taken real yields in a number of developed markets negative.”

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Emerging market details

Real yields in emerging markets are firmly positive. For example, as of late April, Brazilian 10-year bonds had the highest real yield in Lawrence’s portfolio, at about 7%. South African 10-years were yielding about 3%.

“Those are inflation-adjusted yields,” Lawrence said, adding that “from a nominal yield point of view, of course, the yields are much higher.” Nominally, Brazilian 10-years were yielding about 10%, while South African 10-years were yielding about 8%. They compared favourably to the FTSE World Government Bond Index, with its yield-to-maturity of 1.44% for 7-10 years as of April 30.

When assessing nominal and real yields in emerging markets, Lawrence looks for “an alignment of those attractive higher real yields, where we can really create a nice yield tailwind in the portfolio.”

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But higher real yields alone don’t cut it.

“It’s got to be coupled with [a] catalyst to unlock that value,” says Lawrence. For emerging markets, that catalyst is global synchronized growth, he reiterates, supported by “reasonably accommodative” monetary policy.

Lawrence’s analysis of real yields, in general, involves examining underlying macroeconomics, including countries’ fiscal outlooks. Plus, “We’re looking at nominal debt loads, we’re looking at pension trends—a really broad array of macroeconomic data,” he says.

It’s important to look at “the whole external side of each economy, [such as] who a country’s trading with, what are they trading. If they’re commodity-sensitive, what’s our view on commodity prices—how [does] that factor into the fiscal situation for that country?”

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For example, though Russian 10-years yield more than 7% nominally, Lawrence refrains from holding them because of governance concerns.

“We like the way we’re set up,” he said, referring in April to portfolio positioning that took advantage of emerging market yields. “Those higher real yields give a nice yield tailwind to the portfolio.”

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