Investors flock to EM debt in yield-starved world

With most global fixed income markets priced for perfection, investors are flocking to the one yield hold-out left: emerging market debt. But are investors really being compensated for the risk?

Investors have been allocating aggressively to emerging market debt this year. As PA sister title Expert Investor reported last week, the asset class has been on an unprecedented run, both in terms of inflows and returns.

“We think the biggest opportunity for fixed income is in emerging markets. Investors looking for yield can find an abundance of it in emerging markets, and compared to developed markets, growth is much better. The demographics, by and large, are also much more positive, meaning the sector presents the best risk/reward opportunity,” says Kenneth Leech, chief investment officer at Western Asset.

The company’s flexible bond fund, the Legg Mason Western Asset Global Macro Opportunities Fund, has doubled its exposure to emerging market debt this year. It now has a record 47% allocation to emerging market debt.

“Local currency is more attractive than hard currency debt. Spreads have tightened a lot more in hard currency”

Arild Orgland

Arild Orgland, managing partner at the Norwegian wealth manager Industrifinans and an investor in the above-mentioned fund, has noticed most of the flexible bond funds he owns have increased their exposure to emerging markets. And he approves of that.

“There is still spread compression potential in emerging markets, which is no longer there in developed market debt. Local debt also has currency appreciation potential,” he says.

Investor interest in emerging market debt is indeed broad-based, says Nish Popat, an emerging corporate debt portfolio manager at Neuberger Berman.

“We have had inflows from a variation of sources into all our funds. In short-duration funds, we have especially seen a lot of inflows,” he says. And the money is mainly coming from Europe, says Popat. “European investors feel more comfortable investing in EM debt than Americans.”

An issuer’s market

Sailesh Lad, an emerging market debt portfolio manager at Axa IM, is also enjoying his time in the sun. “We’ve seen net issuance of $50-60bn this year, with supply mainly coming from the Middle East and Asia, that has been easily absorbed.”

Net inflows from Europe alone have exceeded that amount, putting downward pressure on yields. And that isn’t necessarily a good thing for investors having to put that money to work.

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