Posted inEmerging MarketsFixed Income

European investors pile into EM debt

January saw flows into emerging market debt recover after Donald Trump’s election in November had led to two months of net outflows. Net inflows into EMD ETFs amounted to $1.2bn (€1.1bn) over the month. 
 
Ivo Daalder, CIO of Dutch asset manager Robeco, was one of these investors increasing their allocation to emerging market debt in January, though he arguably didn’t do so by buying an ETF.
 
“The spread on EMD is currently higher than on high yield, and at a much higher credit quality, while on average the currencies of the EMD bucket are undervalued,” he said, adding: “Although this does not guarantee that currencies will be a positive driver in the short run, their predictive power rises over time.”
 
Rather ironically, Blackrock’s active management division has just cut its EMD position from overweight to neutral. “We see long-term opportunities in EM bonds, but higher valuations give us pause today,” said the company’s chief strategist Richard Turnill.
 

Daalder’s positive outlook for emerging market debt goes hand in hand with bullishness on the dollar, even though dollar strength usually does not bode well for EM assets. “We have put in place a long position in the US dollar,” he announced. 

Fixed income alternatives

While rediscovering emerging market debt, European investors are not quite ready to delve into EM equities. The asset class continued to see modest net outflows, while investors in the rest of the world again stepped up their investment in the asset class.
 
The preference for emerging market debt corresponds with the picture our researcher got when he recently interviewed fund buyers in Madrid. They told him they are increasing allocation to emerging market corporate debt which they consider a strategic alternative for low-yielding developed market bonds. 
 
There normally is a strong correlation in flows between EM equity and bonds among European investors, and some investors prefer to gain early exposure to EM through bonds, as these are considered less risky than equities. It’s therefore likely that inflows into EM equities will pick up later in the year if conditions remain benign. 

 

Part of the Bonhill Group.