Q&A: What's driving EM bond performance?

11-21-2017

Portfolio manager Jason DeVito offers his perspective on what’s driving the emerging-markets (EM) asset class and whether it has room to run.

Q: What factors support EM bonds? The biggest factors are widespread signs of economic growth, pro-market and political reforms and strengthening of central bank credibility globally. And while each of these components has been recognized by the markets, there are still pockets where they haven’t been fully priced into valuations. For example, in Brazil, Chile and Peru, we continue to see tame inflation expectations as well as confidence that their central banks won’t resort to chasing growth even in the face of economic challenges.

Another key factor is China moving forward on a fairly steady growth path, avoiding a previously feared hard landing. Along with supporting the global economy, China’s resiliency particularly benefits commodities-producing areas in Latin America and in Africa. And Africa itself is fast becoming a major driver of economic growth, with many countries such as Kenya and Nigeria morphing from the frontier space into EM status. The increasing prosperity and stability of these and other African countries deliver a tremendous boost to investments into these areas. Along with parts of Africa, one of the most positive EM markets is India, abetted by a stable government committed to economic reform and very strong underlying mid- to long-term growth potential.

Clearly there is wide dispersion of value and risk across EM countries and that is something that can rapidly shift. But understanding those factors is what supports us in pursuing alpha.

Q: How might developed-market rate hikes affect the emerging markets? We don’t expect a negative impact. First, central bank tightening in the U.S. and European Union (EU) has been well telegraphed and is anticipated by EM countries. Monetary policy normalization caused by economic growth isn’t the same as rapid rate increases used to fight out-of-control inflation. In an environment where the global economic outlook is generally positive—as we believe it is—the outlook for EM bonds remains favorable because of their potential for higher yields relative to other fixed-income options.

Also, external balances in EM countries are healthier than they have been in the past—that is, the money coming in from exports is aligned to money spent on imports. Overall, these countries are much better equipped to withstand impacts from higher rates in the U.S. and EU.

Thanks, Jason.