The inflow of hot money into emerging market (EM) bonds over the past few months has prompted concerns that this asset class could become overpriced for investors. However, Abbas Ameli-Renani, global emerging markets strategist at Amundi in London, says EM debt remains an attractive investment option, given its price and improved fundamentals.
“Bond yields have declined in EMs since the beginning of the year, making the assets less cheap than before. However, we think EM debt is far from expensive at this stage, given the improved fundamentals and benign inflationary environment. While it is possible that the current rally in EM assets will eventually lead to the assets becoming too expensive, we are far from that stage,” he adds.
Ameli-Renani says the EMs’ fundamentals, which are the biggest concern of investors, have improved this year. This is reflected in their growth and current account balances. He adds that EM growth has picked up from above 3% to about 4% in recent years.
The Purchasing Managers’ Index shows that the EM service sector has improved despite the slight drop in the manufacturing sector. Current account balances of EMs increased to more than 1.5% in September from about -0.5% in 2013.
“We wouldn’t be surprised to see the growth differential between EMs and developed markets widening this year and next, which will make this the first time in five years,” says Ameli-Renani.
Inflation rates in EMs, measured by the 10-year average real rates, were almost 2% higher than in developed markets in September. This will provide more room for the governments of these EMs to ease their monetary policy, moving forward, says Ameli-Renani.
Despite the weaknesses seen in EM currencies, he does not believe they will weaken to the levels seen in 2013, when the taper tantrum occurred and resulted in huge current account balance deficits in these countries. “EM currencies should not go back to the pre-2014 levels. They adjust based on their fundamentals and they have depreciated significantly in the last two years when commodity prices plunged. This allowed EM fundamentals [and currencies] to stabilise,” he says.
Money continues to flow in
Will there be more upside for EM bonds this year? Ameli-Renani believes so, saying that while US$50 billion had flowed into EMs as at September, which suppressed bond yields, the amount is still low compared with pre-global financial crisis levels.
“There is still a structural underweight from pension funds, sovereign wealth funds and corporates globally in EM bonds. Only 8% of global fund flows are dedicated to EMs now. This used to be 13% to 14% before the global financial crisis. We believe that moving forward, these funds will buy into more EM bonds, thereby causing the inflows to continue,” he adds.
For instance, the Japanese Post Bank will have about US$150 billion invested in the global markets next year and EM debt could be an investment option. The amount is almost three times larger than the total inflows year to date.
“If you look at the US$50 billion inflow so far, you can see how one would not be particularly concerned about money flowing into EMs too quickly,” says Ameli-Renani.
He adds that the low foreign bond holdings in EMs, coupled with the negative-yield environment globally, will continue to drive bond prices up as investors hunt for yield. “About two-thirds of bond markets globally are giving investors negative yields. And there is 50% of eurozone bonds giving negative yields.”
As at August, the value of negative-yielding bonds had swelled to US$13.4 trillion (RM56.2 trillion), according to the Financial Times.
Soft landing for China
Ameli-Renani says the risks of investing in EM bonds are emanating from China’s debt levels and the uncertainties surrounding a US Federal Reserve rate hike and if Donald Trump wins the US presidential election. He says the market is worried about China’s private sector debt, which has exceeded 200% of its GDP while its economic growth has been slowing down. Historically, this phenomenon has led to a financial crisis, which happened in the US and the UK.
However, Ameli-Renani says China’s debt is largely domestic, with foreign assets equivalent to only 14% of its GDP. That means its economy is less vulnerable to external uncertainties. “This is in contrast with other countries that experienced a financial crisis as a result of a sharp increase in foreign debt.”
The “second source of comfort” is the fact that the bulk of China’s corporate debt is quasi-sovereign debt, that is, debt issued with government backing. “This could ensure that when the deleveraging starts, it will be a smooth process instead of a disruptive one. This gives us a bit of comfort,” he says, adding that he expects China’s economy to have a soft landing instead of a hard one.
Meanwhile, Ameli-Renani points out there has been less volatility in EM currencies since 2013 after the Fed’s rate hike announcements. This shows that markets are becoming more comfortable with such news.
Ameli-Renani says investors should not be overly bearish in the event that Donald Trump wins the US presidential election next month. If that happens, the market is expected to price out the Fed interest rate hike, which will lessen the impact of the event.
“Bear in mind that central banks are looking for excuses to be dovish. And what better excuse than that [Trump winning the election]? This is like after the Brexit vote. It was largely perceived to have a negative impact on global and EM growth. But the first thing the market did was to price in more monetary easing and a delay of the Fed hike. We would not be surprised to see a similar reaction if Trump wins,” he says.
Bullish on Latin America debt
Selected Latin American countries’ local currency bonds have started to look attractive and is expected to provide investors with good returns moving forward, says Sergei Strigo, head of emerging market debt and currency at Amundi in London.
He says the valuations of Brazilian and Argentinian bonds are cheap due to country-specific issues as well as global commodity prices, which have plunged in recent years. Commodity prices, which stabilised this year, are a boon to both countries, he adds.
In Brazil, a scandal involving national oil company Petrobras forced Dilma Rousseff to relinquish the presidency, making way for a more market-friendly government. “The impeachment of Rousseff has seen a more market-friendly government come to power and it has just passed a fiscal reform to revive the economy. The reform was passed with a large majority. As a result, we saw a rally in Brazillian debt recently,” says Strigo.
In Argentina, its government had faced a debt restructuring issue with its sovereign bonds for 15 years, owing to its inability to pay off its debts to lenders, including several hedge funds. The government recently reached a settlement with the hedge funds and restructured its debt. “The Argentinian debt is also one of the best performing assets after it was restructured and made current,” says Strigo.
He is also bullish on other Latin American countries such as Peru and Bolivia because of the political changes taking place. “The Latin American countries have experienced the most significant political changes in the past 10 years, which have seen more market-friendly and fiscal-prudent governments come to power. This is the beauty of the fall in commodity prices in recent years. The previous socialist governments used to rely on high commodity prices for their social spending until they had no more money left. Then, they were replaced by the new governments.”
In Asia, Strigo likes Malaysian government bonds as they are the second highest-yielding investible bonds in Asia. He also expects further upside for the ringgit.
“The inflation pressure is persisting in Malaysia and the central bank has maintained its interest rate, stable with a gradual easing bias. On the currency side, there is a lot of political risk premium there,” he says.
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