Emerging market bonds – downturn may be a good time to buy

05.09.2018

It has been a very weak year for emerging market bonds. In future, it is possible that the asset class will perform again but it depends to a high degree on the trend in US yields, commodity prices, economic growth in China and the rhetoric relating to a trade war between the US and China. But if investors have an investment horizon of at least three years, the downturn may be a good time to buy.

Emerging market bonds – drastically widened credit spreads

August offered a return of -1.8%, and year to date, the return was -6.9%. Turkey seized the biggest headlines due to the pending conflict with the US, and the credit spread widened from 432 to 598 basis points. But also Brazil (from 263 to 337 basis points) and Argentina (from 555 to 771 basis points) experienced an extremely weak month. All three countries carry heavy weight and account for approx. 3% of benchmark. Currently, we are overweight in Argentina and underweight in Brazil – in Turkey we have a neutral position.

The total credit spread has widened from 327 bp to 370 bp. The underlying government bond yields have declined by approx. 10 basis points, which does not offset the widening of the credit spread.

Local-currency emerging market bonds – strong pressure on currencies

In August, the return came to –4.7% - year to date, it was -8.1%. The negative return was primarily due to the trend in exchange rates. We have seen strong pressure on the currencies of several countries. Especially Turkey has been hit, and the currency depreciated by just above 25% against the dollar. A failed monetary policy, a too relaxed fiscal policy, a high USD debt in Turkish businesses and a diplomatic crisis with the US were tough conditions for Turkish assets. Turkey accounts for 3.6% of benchmark - in comparison, Argentina accounts for 0.8%, Brazil 10% and Russia 4.7%.

The Argentine peso also depreciated by just above 25% against the dollar. In June, Argentina received a historically large rescue package from the IMF, which did, however, not calm down the markets. At the end of August, the country had to ask for the planned payments from the IMF to be moved forward. Other high-yielding currencies such as BRL, ZAR and RUB weakened by 8%-10% against the dollar in August.

The yield to maturity of the asset class is at 6.87% against 6.55% in early August, which also explains some of the negative return.