For much of this decade, emerging market debt (EMD) was one of the asset classesmost sought after. However, the asset class’s fortunes have reversed in recent years. While it had been growing exponentially this century, its expansion came to a grinding halt in 2014 and since then performance has been capricious, to put it politely.
Is this just a temporary setback or is the long-term investment case for the asset class in jeopardy? Expectations of emerging markets were set too high by investors, and that has now come back to haunt the asset class, according to Arnab Das (pictured below), head of EM fixed income research at Invesco.
“Partly on the back of cheap money created by QE, investors made the mistake of piling into a number of EM countries with the naive view that all growth in the world was now going to come from EM,” he says. That has obviously not been the case, and just one of the consequences has been a weakening of emerging market currencies.
The fact that most of the growth in emerging market debt has come from local currency (government) bond issuance means this asset class has come under particular scrutiny. Because of the currency slide, local currency bonds have been by far the most volatile and worst-performing fixed income asset class over the past two years. As a consequence, investors have been turning their backs on the once-fashionable sector.
A change of sentiment
A look at historical investment sentiment data gathered by Expert Investor over the years shows the depth of the problem. Back in September 2013, memories of the so-called ‘taper
tantrum’ – which gave a first hint as to how risky investing in emerging market bonds can be – were still fresh. Nevertheless, European fund selectors remained constructive towards emerging market government bonds; those planning to increase their exposure to the asset class outnumbered those intending to sell by a factor of three on a pan-European basis, and a large majority of investors were invested in the asset class in all European countries except Norway.
How different the picture is now: close to one in three fund buyers have abandoned the asset class altogether and in most countries sellers outnumber buyers. For emerging market corporate bonds, the picture is very similar, even though they have held up much better over the past 12 months. Fund flows have followed a similar path. Right up until the aforementioned taper tantrum hit the asset class in June 2013, European investors steadily poured money into EM bond funds.
One investor who has disengaged from emerging market debt is Rico Bosma, fund analyst at Wealth Management Partners in the Netherlands. At the end of 2014, he sold half of his EMD-holdings, which consisted of the Neuberger Berman Emerging Market Debt Local Currency Fund and the Franklin Templeton Emerging Markets Bond Fund.
He sold the rest of his EM holdings in autumn last year, as the possible impact of the devaluation of the renminbi had discomforted him. “We had the idea that outperformance should be possible in this asset class but that turned out to be more difficult than expected,” he says.The following year, outflows and inflows alternated, before investors started deserting the asset class last summer. From July to December 2015, a net €17.8bn was pulled from emerging market debt.