Higher yields, fiscal reform and economic growth are tempting institutions back into EM debt. Mark Dunne asks if the rewards are worth the risk.
The emerging markets are back. Institutions are returning to debt issued by developing countries four years after dumping it for assets closer to home. High yields are driving the rotation that is making emerging market paper a prized asset among fixed-income investors once again. The result is a 25% jump in the value of debt issued by developing nations. In the opening six months of 2017 emerging market governments sold $118.6bn of debt, according to data compiler Dealogic. This beat the $94.5bn raised in the first half of 2016, the period when the current bull market is believed to have commenced. One man with an interest in the market believes that this is just the tip of the iceberg. Jan Dehn, head of research at emerging market-focused investor Ashmore, expects more cash to quit developed market assets and find its way into the emerging world. “The real institutional flow has not started yet, not in earnest,” he says. “We have a lot more coming here.” This he puts this down to pension funds typically being slow to move when refreshing their portfolios. Dehn believes that it can take between 18 to 24 months for an institution to allocate its cash after spotting an opportunity in the market. If he is right, then we will see “significant” institutional inflows picking up within the next six months. Even news of $2.3bn pulled from high yield emerging market debt funds during one week in August is not enough to blunt his optimism. He dismisses this as “nothing to worry about”, claiming that it is short-term trading by retail investors concerned by geopolitical events, such as the standoff between the US and North Korea. “That is like focusing on the waves of the Pacific rather than looking at what is under the surface,” he says. “Institutional investors are the backbone of the flows into this asset class.” As an emerging market-focused investor, Dehn’s bullishness could be little more than an attempt to entice new capital to the group and avoid existing clients from becoming former clients. There are, however, examples backing his claim that foreign institutions are putting the emerging markets back into their fixed income strategies. Ashmore paid £20bn in redemptions during the turbulence that hit the emerging markets between 2013 and 2016. In a sign that capital is coming back the group’s assets under management increased by 20% in the year to June 2017. Then there is Argentina. In July South America’s second largest economy made the headlines when it raised $2.75bn through issuing a 100-year bond. Despite the country’s $95bn default in 2001 still fresh in the memory, and it only paying 8%, the offer was over-subscribed.
“I’m bullish on the EM fixed income asset class. It will dramatically outperform developed markets in the next five years.”Jan Dehn, Ashmore