We have increased local currency emerging market debt weightings to neutral as they may have seen off the worst of the turbulence.
We have lowered exposure to emerging corporate debt to lock in gains encouraged by the healthy returns the asset class has delivered this year, although we believe developing world corporate bond issuers are not as vulnerable to the strong US dollar as some fear.
The US’s first interest rate hike in some 10 years is unlikely to be followed by an aggressive round of monetary tightening, which means the scene could be set for a recovery in some emerging market currencies.
We have positioned for this by scaling back many of our short positions in EM currencies and by increasing our exposure to local currency emerging sovereign bonds from underweight to neutral. With yields of some 7 per cent, valuations are beginning to look attractive.
We are gradually building exposure to the markets worst hit by the sell-off – Brazil is one local currency bond market that might soon recover. Its recent woes – rising inflation, weak growth and a credit rating downgrade to junk status – are more than sufficiently discounted in the price of its debt, now yielding some 15 per cent.
Still, for us to shift our stance to overweight, we would need to have greater clarity on the trajectory of US interest rates as well as evidence of an improvement in emerging market growth.
Elsewhere, we remain overweight US and European high-yield bonds. Default rates among issuers of sub-investment grade debt are low and likely to remain so as the ECB prepares to expand its quantitative easing programme.