Opportunity in EM debt

Emerging markets present an attractive opportunity for investors looking to diversify their portfolios, and emerging market debt offers investors diversification benefits, and enhanced yield and return potential. However, the Russia-Ukraine conflict, a spike in commodity prices and rising inflation have raised questions about of EM debt. US-based investment management firm Capital Group in its report ‘Does the EM debt reprising present a good entry point?’ says that developing economies are now in a much better shape than before, making EM debt an attractive investment opportunity.

While the International Monetary Fund and the World Bank suggest that global growth is slowing, Capital Group is of the opinion that much of the risk has been priced in. The current average yield on benchmark EM indexes is between 6% and 7%, and the asset manager says it is cautiously optimistic about investments in EM debt.

Higher inflation has plagued global economies; however, EM markets were quick to raise key interest rates, which would help protect them from capital outflows, says Capital Group. While inflation is peaking, the asset manager says nominal and real yields in developing countries appear to provide fair compensation. As per the asset manager’s analysis, EM local, hard currency bond yields top US core bonds.

“High starting yields can help offset subsequent price volatility and may signal an attractive entry point for investors seeking to add income-generating bonds to their portfolios,” writes Capital Group in its report.

Based on Capital Group’s research, emerging economies appear to manage fiscal deficits, and public debt levels are also well below those of developed markets. Whereas some emerging markets also have current account surpluses, and high commodity prices are supporting commodity-exporting countries.

While there are certain risks, Capital Group says that the current volatility presents an exciting opportunity for investors. “Proactive central bank actions, fundamentals and technical factors look attractive on a historical basis and relative to developed markets,” writes Capital Group.

View the full insight report here.