Lyubka Dushanova, Portfolio Strategist, Emerging Market Debt, outlines why investors should reassess prospects for EMD right now. Summarising what happened in EMD in 2022 and the opportunities we see for the asset class in the year ahead, Lyubka explains why we believe an indexed approach makes sense. For deeper insights see our paper below – Revisiting Emerging Market Debt: Brighter Days Ahead?
Speaker : Lyubka Dushanova
Portfolio Strategist, Emerging Market Debt
What happened with Emerging Market Debt in 2022?
2022 was a volatile year for markets and EM was at the center of this volatility. Yet when we look at performance of emerging market debt, whether it’s local currency or hard currency debt, we can see that to a large extent underperformance was driven by non-EM factors, namely the US monetary policy, which drive a sharp selloff in US treasuries and strength in the US dollar, both of which are negative for EM.
Of course, there were also EM specific factors, in particular the war in Ukraine, which affected not only the EM, but also global markets through the commodity channel. Also, with a sharp increase in refinancing costs, a number of vulnerabilities in EM were exposed and a number of EM countries had to restructure their debt over the course of the year.
Finally, China which in previous economic cycles has been the motor of growth for emerging markets saw a sharp deceleration in its GDP, registering a GCP of 3% for 2022, one of the lowest prints in its modern history.
What are the prospects for 2023?
Although 2022 was a painful year, we do think that this leaves us with a significantly improved out look for the asset class this year. If we take hard currency sovereign debt for example, we think that the story there this year, is one about carry. With a yield of over eight and a half percent for the JP Morgan and EMBI Global Diversified Index we believe the asset class offers attractive compensation for income seeking investors.
We also have to remember that the spread widening in the EMBIG index has really been drive by the high yield names in the index which represents almost half of it. The good news there is that most of the vulnerabilities, most of the negative stories have already been exposed and priced in. And so even if we see some spread volatility like we saw this year driven by market sentiment, we expect that this is going to be offset by a rally in Treasuries like we saw in March this year.
In local currency debt we think that there are good catalysts for local rates to outperform this year. And the reason for that is really because EM central banks have been ahead of the curve this time around. They started hiking rates more that half a year ahead of the Fed, and as a result EM inflation is now peaking in most places. Some EM central banks have paused their hiking cycles and we do think that some of them will even start cutting over the course of 2023. On the FX side EM FX has been undervalued versus the dollar for more than two years now but we do think that this is more of a reflection of the dollar strength rather than weakness in EM. We think that the dollar will remain volatile, driven by the Fed monetary policy and by market sentiment. And so we expect that in local currency debt performance this year is really going to be driven by the rate side.
The Benefits of an Indexed Approach in Emerging Market Debt
We believe that our indexed approach is suitable to this type of highly volatile market environment because it provides an efficient exposure to the beta of emerging markets.
Contact us at SSGA_InsightsEMEA@ssga.com
Marketing Communication. For investment professional use only.
The information contained in this communication is not a research recommendation or ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with the Markets in Financial Instruments Directive (2014/65/EU) or applicable Swiss regulation. This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research.
The information provided does not constitute investment advice as such term is defined under the Markets in Financial Instruments Directive (2014/65/EU) and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell any investment. It does not take into account any investor's or potential investor’s particular investment objectives, strategies, tax status, risk appetite or investment horizon. If you require investment advice you should consult your tax and financial or other professional advisor.
This communication is directed at professional clients (this includes eligible counterparties as defined by the appropriate EU regulator or applicable Swiss Regulator) who are deemed both knowledgeable and experienced in matters relating to investments. The products and services to which this communication relates are only available to such persons and persons of any other description (including retail clients) should not rely on this communication.
Bonds generally present less short-term risk and volatility than stocks but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss. International Government bonds and corporate bonds generally have more moderate short-term price fluctuations than stocks but provide lower potential long-term returns.
Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries. Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations.
Investing in high yield fixed income securities, otherwise known as "junk bonds", is considered speculative and involves greater risk of loss of principal and interest than investing in investment grade fixed income securities. These lower-quality debt securities involve greater risk of default or price changes due to potential changes in the credit quality of the issuer.
Investing involves risk including the risk of loss of principal. Past performance is no guarantee of future results.
All information is from State Street Global Advisors unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
This document/video may contain certain statements deemed to be forward-looking statements. All statements, other than historical facts, contained within this document that address activities, events or developments that State Street Global Advisors expects, believes or anticipates will or may occur in the future are forward-looking statements. These statements are based on certain assumptions and analyses made by State Street Global Advisors in light of its experience and perception of historical trends, current conditions, expected future developments and other factors it believes are appropriate in the circumstances, many of which are detailed herein. Such statements are subject to a number of assumptions, risks, uncertainties, many of which are beyond State Street Global Advisor’s control. Please note that any such statements are not guarantees of any future performance and that actual results or developments may differ materially from those projected in the forward-looking statements.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
All the index performance results referred to are provided exclusively for comparison purposes only. It should not be assumed that they represent the performance of any particular investment.
The views expressed in this material are the views of Lyubka Dushanova, Portfolio Strategist, SSGA’s Global Fixed Income Group through the period ended 24 March 2023 and are subject to change based on market and other conditions.
The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.
Information Classification: General Access
© 2023 State Street Corporation — All Rights Reserved
Tracking Code: 5554194.2.1.GBL.RTL
Expiration Date: 31/03/2024