The historical risk-return profile of Emerging Market Debt (EMD) compares favourably with its developed market counterparts: investors willing to tolerate the inherent volatility have been rewarded with higher returns over the longer term, thanks to a compelling risk premium.
New research commissioned by NN Investment Partners (NN IP) shows that professional investors do indeed appreciate the long-term benefits of holding EMD over the longer term, with the majority (62%) saying it is an attractive investment over five-plus years. By contrast, only 9% believe it is unattractive over this term.
The research also shows that there is only slightly less enthusiasm among professional investors for holding EMD for the short term: just over half (51%) of respondents believe that EMD is still attractive over a one-year period, including 6% who believe it is ‘extremely attractive’. Scepticism is a little higher for short term positions than for long-term positions in EMD, with 17% saying it is unattractive over one year.
NN IP believes that EMD offers attractive opportunities for both long-term and short-term allocations.
The market fundamentals in EMs are superior to those in DMs. Emerging economies, which have enjoyed higher growth rates since 2000, account for 40% of global economic output yet only 13.2% of global domestic debt and just 8.3% of external debt. Their growth trajectories are also strongly supported as they benefit increasingly from globalisation, younger populations and their governments’ ever-improving credibility. While these factors are favourable for the risk-return trade-off, they also create short-term tactical opportunities.
Marcelo Assalin, head of Emerging Market Debt, NN Investment Partners, explains: “There are unexpected situations with regards to all investments but the surprise factor is more prevalent in emerging than developed markets. This helps explain the relatively higher volatility of emerging market debt. Therefore, investors need some patience to absorb shocks and reap higher returns over the longer term. It is important to keep in perspective the strong fundamentals of emerging market countries.”
“Institutional investors focused on long-term strategic asset allocations could add value to their portfolios exploring dynamic, short-term investment policies to benefit from short term market dislocations created by high volatility. For example, they could tactically increase exposure to EMD in periods of market corrections driven by short term technical factors”
“If investors examine the risk premium they get with EMD compared with other fixed income asset classes, they soon realise they can have higher long term returns at a similar risk profile.”