Emerging bond markets continue to generate attractive returns. In February, the JP Morgan Emerg...
Emerging bond markets continue to generate attractive returns. In February, the JP Morgan Emerging Market Bond Index Global (EMBIG) generated a 3.2% return in US dollar terms while returning 12.29% over the past 12 months.
In the previous year, weak global economic conditions and volatility in select countries created a stress test for emerging bond markets and yet emerging debt market performance still generated strong returns and outperformed most US-dollar fixed income asset classes on an absolute and risk-adjusted basis.
There are several noteworthy characteristics and developing trends of emerging bond markets that correspond to the asset class's broadening investor base.
First, emerging markets offer attractive returns over the long run given the level of risk assumed, particularly among the higher rated credits.
Second, recent country specific emerging market negative events have generated comparatively lower volatility as contagion effects have lessened. This is due to the greater use of floating exchange rates, increased levels of foreign reserves to help cushion the impact of external shocks, as well as greater depth and breadth of the asset class as it continues to mature. Additionally, emerging debt market returns exhibit diversification benefits through low correlation to most US-dollar fixed income asset classes. A reduction in interest rates in developed economies generally benefits emerging market borrowers, as it lowers financing costs and can attract positive capital flows as investors seek higher returns outside developed countries.
As expected, several countries successfully accessed international capital markets in late 2002 and early 2003 on the back of strong investor appetite and narrowing spreads.
During the past 12 months, we saw a dichotomy in performance between Latin America and non-Latin American emerging bond market returns.
Latin American sovereign debt returned 6.53% compared to non-Latin America returns of 19.51%. Currently, Latin America sovereign interest spreads over US Treasuries are at 8.91%, compared to non-Latin spreads of 3.95%.
Asian emerging bond markets provide relative stability, particularly considering the positive risk-adjusted return macroeconomic and sovereign credit profiles of countries such as South Korea and Malaysia, and help investors to position defensively given global economic uncertainty and yet maintain attractive yields.
Eastern Europe continues to generate attractive returns given the improvement in the macroeconomic and credit fundamentals of certain countries in the region.
In particular, Russia was the top-performing emerging market credit in 2002 and the largest holding the Templeton Emerging Market Bond Fund; it returned 31.61% over the past 12 months. Continued international reserve accumulation illustrates the robustness of the balance-of-payment position, which itself is function of strong exports and capital flows into the country.
Ongoing structural reforms and increased political and financial stability have improved the investment climate and led to a return of foreign direct investment to the country, as highlighted by the announcement by BP to invest into the Russian oil venture, Tyumen Oil.
While higher oil prices have supplemented overall macroeconomic strength, prudent debt and fiscal management have allowed the country to improve underlying credit fundamentals through early repayment of obligations and decreased reliance on external markets for financing.
The Templeton Emerging Market Bond Fund A shares returned 2.6% and 6.9% over the past 12 months.
The Templeton Emerging Market Bond Fund is positioned to reflect a defensive outlook with respect to certain countries in Latin America and a positive outlook on Eastern Europe, particularly Russia, and Asia.
Looking forward, emerging market economies should benefit from continued structural reforms, coupled with increased foreign direct investment flows, to the benefit of emerging market debt prices.
In the short term, the emerging debt market asset class could experience short-term volatility due to the uncertainty surrounding the conflict with Iraq.
Our strategy is to take advantage of such short-term volatility to add to existing positions that exhibit improving macroeconomic and credit fundamentals.
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