Prior to the onset of COVID-19, much had been written about the appeal of emerging market debt (EMD), touting the yield advantage as well as its lower correlation to other fixed income asset classes. EMD has underperformed since then, leaving investors in Switzerland and beyond to wonder if and how EMD fits into their asset allocation. After a difficult start to the 2020s, we believe EM debt is now poised to outperform as headwinds from sharp increases in interest rates and slower growth are now reversing course. Thus, the tailwinds from lower rates, higher growth, and improving credit quality are setting the table for positive EM performance going forward.
The Maturation of EM Economies
The reversal of inflationary pressures has led many EM central banks to begin rate cutting cycles. At the same time the tailwinds that have been powering EM growth for years are nearing a tipping point as many EMs move from maturing to matured. While some weaker emerging markets have suffered, most emerging market economies have remained quite resilient from a fundamental standpoint. This is a result of better policy implementation by emerging market governments and central banks, as well as exports’ boost to growth and current account surpluses.
Emerging markets are not only home to the fastest growing countries, but they also control the majority of the world’s GDP. In 2007, emerging markets overtook developed markets share of global GDP as China’s rapid growth after 2000 drove significant gains. Since then, EM has only continued to widen that gap. Excluding China, emerging markets’ share of global GDP is expected to overtake developed markets this year.
How much faster emerging markets are growing than developed markets has historically been the largest driver of returns in EM. Looking at it from a Fixed Income perspective, when EM/DM growth differentials have been above 2%, EMD has historically outperformed U.S. high yield. When that growth differential dipped below 1.5% in 2021 and 2022, EMD underperformed strongly, primarily due to the severity of successive shocks post-COVID.
Read the full ‘Sponsored Commentary’ article at the link below
