Emerging market debt is in a rally and has seen an increasing inflow of capital in recent month...
Emerging market debt is in a rally and has seen an increasing inflow of capital in recent months. But managers have mixed opinions about the future of the asset class: some believe there has been a shift away from irrational investor behaviour that has made it less risky and more attractive to long-term capital; others say the market environment is good, but could easily turn bad.
According to EmergingPortfolio.com Fund Research (EPFR), a US firm with data on more than 3,000 international and emerging market funds, emerging market bond funds have recorded record amounts of capital inflow,
The 171 dedicated emerging market bond funds with $9.7bn in assets covered by their data, saw net inflows of $173.64m in the week ending 12 March ' a 1.8% gain in total assets due to fresh money.
According to EPFR data, which is collected directly from the funds or their administrator, these funds absorbed inflows of $864.7m in the year to that date.
Brad Durham, a managing director of EFPR, says: 'We have not seen emerging market bond flows this strong since we began tracking these funds in 1995. The pace of flows into the bond funds year to date is nine times stronger than last year during the same period, and the amount of money that has gone into these funds in the first 10 weeks of this year is almost equal to all of last year's total inflows.'
This investor interest comes in response to an emerging market bond rally that began six months ago.
There has been an increasing weighting in Latin America in recent months and may be growing investment in Brazilian debt, where sovereign debt has received an upgrade, he adds.
According to Jerome Booth, head of research at Ashmore, the nature of emerging market debt has changed, and this has made it more attractive for long-term investment.
Market contagion caused by irrational investor behaviour has largely disappeared, he says. This, combined with a market rally, has made emerging markets popular.
Emerging market debt is also attractive because it is anti-cyclical to the global business cycle, has a negative correlation to global bonds and provides natural protection from the global oil cycle, he adds.
There has been much progress in emerging markets that has not been priced into emerging market bonds, leaving it 'massively under-priced,' according to Booth. Russia, Brazil and Mexico are the most attractive positions in the asset class, he says.
Brazil is recovering fast from an uncertain period before the recent election of its new, left-wing prime minister, Lula. 'It has no major problems, but is valued cheaply,' says Booth. 'Lula has been a success so far, but the market thought he would not be.'
Once interest rates start to come down and growth becomes stronger the picture will look even better, he adds. Mexico is attractive because it is an investment grade country with cross-over investors from the US.
Russia is in a rally, has recently received a huge investment from BP, and reform there is continuing at pace. On top of this the macro environment looks very positive, he says
Peter Lucas, global investment strategist at Ashburton, is more cautious about the asset class. Emerging market debt has performed well, but if circumstances change so could performance, he says.
An improving global economy has taken the edge off risk aversion, which has increased the flow of assets into emerging market debt funds, he says, and despite talk of deflation we have actually seen inflation.
Contagion is still a problem in emerging markets, according to Lucas. 'When Latin American credits move they all move together subject to specifics,' he says. He is overweight Brazilian debt, which he believes is cheap.
Philippine debt is also attractive. Worries on the size of its budget deficit, terrorism and the global economy are overstated, he says.
Columbia is another interesting area, according to Lucas. 'The president is taking a firm line against terrorists and this will get US support,' he says.
'Within the emerging market universe they still offer value.' He does not like Russia because, he says, the short-term picture there is uncertain and its split with the US over Iraq could prove costly.
Latest news and analysis
Drip-feed. Blend. De-risk
£92bn transferred since 2015
Achievements, charity work and other happy snippets