3 Reasons To Allocate To EM Bonds In 2023

Relative to developed markets, emerging markets responded quicker to inflation, remain in better shape financially, and benefit from higher commodity prices.

In our 2023 outlook, we highlighted emerging markets bonds as a compelling opportunity. Below we explore three reasons investors should consider allocating to emerging market (EM) bonds in the current market environment.

1. Emerging Markets Have Lower Debt

Notwithstanding China’s more recent policy direction, emerging markets, in general, have moved much more quickly to increase interest rates compared to the U.S. and other developed market (DM) rates in order to stay ahead of inflation. For investors, this fundamental backdrop means less issuance and rolling over of debt, a favorable supply/demand dynamic that should help support EM bonds. In addition, if needed, EM central banks can hike interest rates without bankrupting the government (like we saw in the United Kingdom).

Debt Levels of EM Countries Are Relatively Attractive

General Government Gross Debt (% GDP)

2. EM Has Independent Central Banks

The primary focus of EM central banks is to focus on controlling inflation, and they do this by maintaining high real interest rates. For investors, the result has been not only higher nominal yields but higher real yields. The benefits to EM local currency investors are a more substantial level of income that is not eroded by the loss of purchasing power (through a potentially weaker currency). Additionally, if the central bank’s actions are successful in controlling inflation, it can lead to a stronger and more stable economy.

EM Central Banks’ Focus on Inflation Means Higher Income for Investors

Real Policy Rates in EM and DM (%)12m from now if current expectations for rates and inflation materialize

Real Policy Rates (Trailing) in EM and DM (%)

3. EM Benefits from Higher Commodity Prices (with a Boost from China’s Reopening)

Unlike developed markets, which experience higher commodity prices as a price shock, emerging markets export more commodities than they import, which means they benefit from higher prices. This dynamic means emerging markets are good creditors in dollar terms and have dollars on hand to stabilize their local currency if needed.

And for investors choosing between equity and debt exposure in emerging markets, keep in mind that net commodity exporters make up a much more significant portion of most EM local debt indexes than they do of EM equity indexes, which tend to be much more concentrated in the Asian export-led economies.

As it relates to China, global markets spent 2022 digesting the property sector collapse and strategic divorce with the U.S., and are only slowly waking up to China reopening. This is very supportive of commodity prices. After rumors and hints of a change in China’s Zero-Covid policy, it now looks like China has significantly loosened controls; this is a clear change in policy. It is also accompanied by an increasingly accommodative macro policy. EM debt stands out as having asset prices that can benefit directly from China reopening with its high-carry bonds that can generate returns in a potentially sideways, choppy or bumpy bond world. Many EMs stand out as beneficiaries of higher commodity prices, not victims of them.

Important Disclosures

Please note that VanEck may offer investment products that invest in the asset class(es) or industries included in this commentary.

This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities/financial instruments mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not reflect actual results, are valid as of the date of this communication, and subject to change without notice. Information provided by third-party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.

Duration measures a bond’s sensitivity to interest rate changes that reflects the change in a bond’s price given a change in yield. This duration measure is appropriate for bonds with embedded options. Quantitative Easing by a central bank increases the money supply engaging in open market operations in an effort to promote increased lending and liquidity.

Emerging Market securities are subject to greater risks than U.S. domestic investments. These additional risks may include exchange rate fluctuations and exchange controls; less publicly available information; more volatile or less liquid securities markets; and the possibility of arbitrary action by foreign governments, or political, economic, or social instability.

Investments in emerging markets bonds may be substantially more volatile, and substantially less liquid, than the bonds of governments, government agencies, and government-owned corporations located in more developed foreign markets. Emerging markets bonds can have greater custodial and operational risks, and less developed legal and accounting systems than developed markets. When interest rates rise, bond prices fall. This risk is heightened with investments in longer duration fixed-income securities and during periods when prevailing interest rates are low or negative.

All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future performance.

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