By Peter Marber, chief business strategist, for emerging markets debt and currencies, HSBC Global Asset Management
Emerging market debt and currencies have taken up a plethora of newspaper columns and been the subject of many conversations between professional investors over recent times. Many articles and discussions have highlighted long-term potential and benefits but we live in volatile times. But beyond the historic case for emerging markets, investors should rightly ask whether these benefits will continue – whether or not emerging market debt and currencies can and will deliver, on the potential yields and rewards?
Firstly, one has to examine credit fundamentals. While these have certainly deteriorated in the US, eurozone, and Japan over the past decade (reflected in multiple credit downgrades by the rating agencies), most emerging market economies have been strengthening. Debt-to-international debt, a good barometer for credit, has risen from roughly 50% in 2000 to approximately 140%; which means that emerging market countries have flip-flopped from debt to creditor nations. Indeed, emerging market hard currency reserves have swollen from approximately $500bn in late 1996 to more than $8trn by mid-2012. This combination of rising productivity, increased reserves, and greater economic momentum should also be captured in lower emerging market credit risk premia.
Today overall country leverage is comparatively light – roughly 40% or half of the eurozone and US levels. This is why emerging market sovereigns have experienced roughly a 5:1 credit upgrade-to- downgrade trend for the few years. Oddly, amid this strength emerging market sovereign credit spreads look cheap, having actually widened considerably since their recent lows of 150bps above comparable US Treasuries in 2007 to roughly 350bps in mid-2012, a residual of the global credit crisis. In addition to this, investors might also be able to pick up 100-300bps or more from select emerging markets corporate issuers. These additional spreads are the difference between negative and positive bond returns in most advanced economies. The combination of higher current yield and cheap credit spreads, plus higher yields and capital appreciation potential of currencies, makes the fundamental case for emerging market bonds, we believe, very compelling in the current low rate environment. While often being perceived as fundamentally riskier than the US and Europe, the current reality is the opposite; emerging countries have low debt levels, and record levels of cash reserves.
While the long-term trends for emerging market bonds have been good, so have the short-term returns. In 2012, emerging market hard currency bonds have climbed more than 14% through to end of September, versus less than 2% for the broad US and global bond benchmarks. Emerging market local currency has advanced by more than 4% and local currency bonds are up around 9% through to the end of August (Source: Bloomberg). With the exception of another global meltdown, we believe that emerging markets debt has the potential to continue to outperform advanced, developed country debt in most economic scenarios.
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