Looking for Emerging-Market Opportunities? Go Local.
For investors in search of a way to boost income and diversify their bond portfolios, now may be the time to consider what local-currency emerging-market (EM) bonds offer.
Investors have been gravitating to emerging-market bonds over the last year or so—and with good reason. The growth outlook in developing countries is improving, and many governments are embracing economic reform, reducing external vulnerabilities and cracking down on corruption.
But most investors still prefer to buy debt denominated in dollars (Display). That’s partly because many who turned to local-currency bonds in the years after the global financial crisis got burned when market sentiment soured.
Between 2013 and 2015, high deficits in many EM countries and fear of rising US interest rates provoked a rush for the exit. EM currencies plunged and the J.P. Morgan Government Bond Index-Emerging Markets, which tracks local-currency debt, fell nearly 30%.
There’s no doubt that those were tough years for EM assets in general and local-currency debt in particular. But today, these types of EM bonds are the fastest-growing segment of the market—and there’s a lot for investors to like. For instance:
•EM currency values are now attractive. Some Asian currencies, for example, are near 10-year lows against the US dollar.
•Governments in São Paulo, New Delhi, Jakarta and beyond are tightening their belts.
•EM inflation is stable or declining, giving central banks room to reduce interest rates.
•Real, or inflation-adjusted, yields are at historical highs relative to those of developed-market bonds.
We don’t think investors should fret too much about a gradual rise in US rates, either. Higher US rates mean US economic growth is accelerating, and that should be good for EM countries—commodity producers and export-oriented economies alike.