EMERGING MARKET GOVERNMENT DEBT

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THE INVESTMENT CASE

The primary investment case for Emerging Market Government Debt (EMGD) is that it can offer higher yield and potentially higher income, particularly during periods of low global interest rates. Adding an allocation to EMGD can also provide a diversification benefit, due to its historically low correlation with other asset classes.

EMGD HAS IMPROVED IN CREDIT QUALITY, LIQUIDITY AND GOVERNANCE. 

 

KEY ATTRIBUTES

Originally issued only sporadically by individual emerging countries, EMGD began to coalesce and evolve into an established asset class in the fixed income space as confidence grew in the opportunities provided by developing economies. Shaped and supported by the responses to a series of fiscal crises and an extended period of robust global economic growth over the past decades, EMGD has improved in credit quality, liquidity and governance. It has become more resilient and – even in the current uncertainty resulting from the coronavirus – EMGD can offer selective opportunities, especially for better yield.

It’s a complex asset class, given the diverse range of sovereign issuers across Latin America, Europe, and Asia. Consequently, EMGD taken as a whole is subject to a number of risk factors, including economic shocks, currency fluctuations, and political instability – all of which could mean that the governments couldn’t pay back the debt. EMGD is also sensitive to changes in interest rates, particularly from the US Federal Reserve, and to relative strength in the US dollar. This is because many emerging market countries hold debt denominated in dollars. Many emerging market bonds are valued in USD while others are in local currency. To help mitigate currency risk, some EMGD funds offer a blend of both.

HOW EMGD FARED DURING THE RECENT MARKET TURMOIL

During the market fallout from the coronavirus crisis, some of these risks were enhanced. Countries that rely on tourism, for example, will see their economies hit hard in the near term. Some of the larger emerging markets rely heavily on commodity prices, especially oil, which at one point in April was actually negative for the first time in history. Local currencies will have suffered relative to the US dollar, historically considered a “safe haven”, which has generally strengthened since the beginning of the COVID-19 crisis. But high-quality (A rated) emerging market debt has seen single-digit losses during the market lows, in line with government debt from developed economies. And in response to the global economic slowdown, the International Monetary Fund and the world’s central banks have demonstrated strong support, whether directly (emergency IMF loans) or indirectly, through asset purchases and other stimulus measures that have a knock-on effect.

EMGD IS ALSO SENSITIVE TO CHANGES IN INTEREST RATES, PARTICULARLY FROM THE US FEDERAL RESERVE, AND TO RELATIVE STRENGTH IN THE US DOLLAR. THIS IS BECAUSE MANY EMERGING MARKET COUNTRIES HOLD DEBT DENOMINATED IN DOLLARS.

 

OUTLOOK FOR EMGD

Given these structural supports and low valuations, EMGD can offer attractive opportunities as we start to see an economic recovery take shape. Adding EMGD to a multi-asset portfolio can diversify exposure to a range of countries, credit ratings, rates, and durations. As part of a long-term strategy, this asset class can also help provide higher yields at a time when rates are historically low.

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THE RISK REBATE: MAKING THE MOST OF DIVERSIFICATION

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We look at the investment case for Real Estate Investment Trusts (REITs) in a diversified portfolio, including the key attributes, how it has fared during the current market turmoil and the outlook for this asset class.

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