EMD searches on RFPnetworks are amongst the top 5 asset classes by funded AuM. With so many managers globally, finding the best EMD managers requires a huge amount of data, which is one of our specialties. But equally challenging is deciding in which segment of the EMD market to invest.
EMD research inside RFPnetworks therefore tends to receive a relatively large proportion of our daily traffic. And currently, there seems to be a lot of interest in Hard Currency EMD. Which is interesting given there is a lot of information to digest from the YTD Sep 2022 numbers:
Both hard and local currency bonds have had similar outflows. But in September itself, outflows from hard currency bonds were approximately double that of local currency bonds.
Hard currency bond returns are approximately 5% lower than local currency bonds, and have fallen in line with the S&P 500, at a time when the VIX has breached 30 indicating significant market stress.
In contrast, the 5 year return numbers show an outperformance of hard currency bonds over local currency of around 600 basis points. And comparing hard and local currency drawdowns during market stress periods (e.g. the taper tantrum of May 2013), hard currency benchmarks exhibited a trough that was shallower and narrower than that of local currency benchmarks.
The longer term numbers may be a result of lower liquidity (and higher trading costs) for hard currency bonds - ultimately investors want to get paid for the risks they take. But there are many other factors that investors are researching:
The differences in the underlying universes is significant. Hard currency bonds are issued by approximately 70 countries. Local currency bonds by around 20 (of which 10 account for 90% of the main index). So whilst the more widely accepted local currency bond market is almost 10 times larger than the hard currency bond market, there is more diversification to be found in the hard currency market.
That said, 50% of the hard currency universe is below investment grade, compared to 25% for the local currency issuer universe. But with 60% of EM CCC bonds now trading below $40, there could be some interesting hard currency restructuring stories unravelling.
These are but a few of the research topics we see getting lots of traffic today. ESG for sovereign EMD issuers has also become important. As has the impact on EM bonds of the strength of the USD, the price of commodities, supply chain fluidity in light of COVID lockdowns, the opening of the world to tourists, and elevated geo-political risks.
EMD is a fascinating asset class, but still only represents 20% of global fixed income markets. But given the higher yields versus developed markets, it is always on the radar as a diversifier and growth component for fixed income portfolios. And currently EMD Hard Currency seems to be attracting all the attention.