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The Case for Allocating to Emerging Market Debt

Senior Investment Strategist

Emerging market debt (EMD) is a versatile asset class. It offers equity investors risk mitigation potential with modest return dilution. For fixed income investors willing to move out on the risk spectrum, EMD still presents a significant yield pick-up opportunity. There has been a notable rise in indebtedness in some countries and, now more than ever, investors need to be comfortable with headline and idiosyncratic risk, look beyond average index level metrics, and be mindful of individual issuer risks. Emerging markets were certainly not immune to the global yield reset of recent quarters. However, with broad EM yields now at significantly higher levels in absolute terms and an increasing number of EM central banks cutting rates, a growing, albeit guarded, case has emerged for consideration of the asset class in investors’ portfolios.

Key Points

Yield Enhancement Emerging market debt still provides an attractive yield pick-up relative to developed market bonds.

Diversification Benefits The low correlation and higher growth factor exposures of EMD assets provide diversification benefits for global bond and equity investors.

Evolving Fundamentals While emerging economies offer relatively strong growth, China faces a more subdued growth trajectory with implications for its neighbours.

Rate Cycle Some EM central banks may be ahead of their advanced economy peers in the rate cutting cycle and offer potential outperformance opportunities.

Higher Volatility/Drawdown and Idiosyncratic Risks Investors need to be aware of the potential higher volatility and drawdowns as well as the idiosyncratic risks associated with EM assets.

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