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What you may not know about emerging market fixed income

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Insights and Market Perspectives

What you may not know about emerging market fixed income

Author: Sound Choices

April 16, 2019

Emerging Markets:
Quantity, quality, maturity, opportunity

Previously, we covered the 5 reasons to reconsider emerging markets (EM). In this article, we focus in on the fixed income component.


What’s included in the EM universe?

Emerging markets are classified using a number of different metrics and slightly differ among organizations.

The S&P Dow Jones Indices, for example, classify countries by looking at a number of criteria, including the size of the country’s domestic market capitalization, how freely its currency is traded and the country’s economy, specifically its income per capita, also known as Gross Domestic Product (GDP) per person.1

Canada, with its average income of US$45,0322 is one of the “developed” countries. Countries with income per capita of lower than US$15,000 are labelled “developing” or “emerging“.1

This helps explain why Brazil, China and India are on the list of the 10 biggest economies, but are still considered “emerging” – the size of their populations translate into a relatively low per capita income.

Morgan Stanley, on the other hand, in compiling its Emerging Markets Index, looks at the country’s economic development, size, liquidity and market accessibility.

Source: https://www.msci.com/market-classification
Source: https://www.msci.com/market-classification

Frontier markets: the next “emerging” markets

“Frontier” markets – just like EM countries – can be classified using a variety of criteria, but are generally countries with even lower income levels than the emerging market counties and considered less developed based on their economic level and liquidity. In this frontier phase, globally recognized regulatory authorities and administrations are often still in early development, which potentially leads to lower levels of transparency, shareholder and corporate governance.

Interestingly, frontier fixed-income markets tend to be more advanced than their equity ones so you’re more likely to see securities from these countries in a fixed-income portfolio than an equity one.


Who issues EM bonds?

Sovereign bonds are issued by the government. With sovereign debt, the focus is on country risk, mostly driven by fiscal conditions.

EM companies also issue bonds. In fact, the EM corporate bond market is now bigger than the EM sovereign bond market (53% vs 47%, respectively).3 Corporate debt, not surprisingly, is assessed by looking at the company’s credit risk.

Supranational bonds provide alternative access to the emerging markets with a potential to migitate country-specific risks. These bonds are issued by international organizations, such as the European Union or World Bank. As they’re backed by multiple countries, they tend to have higher credit ratings and sometimes better liquidity. Borrowing nations belong to the organization and prioritize payments on these bonds.


How does currency factor in?

Bonds are issued in either external (hard) or local currency.

External currency bonds are issued in ‘hard’ currencies such as the U.S. dollar. Like all U.S. dollar-based bonds, they would be assessed by the spread over U.S. treasuries and therefore tied to U.S. monetary policy.

The first emerging market bonds were issued as external debt because the hard currencies are considered more stable. An EM country tends to offer a higher interest rate on a U.S.-dollar bond than those issued by the American government to take into account the risk associated with it being a developing nation.

Local currency bonds are exactly as they sound – debt issued in the currency of the EM country. Generally, local currency bonds pay a higher yield than external currency ones to compensate for the risk of investing in that particular currency. This type of bond would be assessed by considering quantitative measures such as the country’s monetary and fiscal policy, as well as qualitative issues like geopolitical concerns

Today almost 90% of EM bonds (approximately US$ 21.1 trillion) are denominated in local currency.3 Not surprisingly, an EM issuer would generally prefer to offer a bond in their own currency to avoid potential debt-servicing issues. (If the U.S. dollar appreciates after issuing an external bond, for example, the financial burden or repaying coupon payments and principle increases for that EM country.) A more robust domestic market enables the issuers to do just that. In fact, Asia is almost entirely self-sufficient – approximately 95% of Asian fixed income securities are domestic market bonds.3


Quality – EM bonds not necessarily junk bonds

Investors often compare EM bonds to junk bonds (also known as high-yield bonds, or those with a rating below BBB-), but the comparison can be misleading.

In fact, the chart below shows that, as of December 31, 2018, nearly 60% of EM bonds were rated investment-grade (BBB or higher).

Investment grade bar chart
Source: JP Morgan, data as of December 31, 2018.
Hard currency represented by JP Morgan EMBI Global Index.
Local currency represented by JP Morgan GBI-EM Broad Diversified Index.
The information provided is for illustrative purposes only and is not meant to provide investment advice. You cannot invest directly in an index.

Opportunity – An evolving, growing market.

EM fixed income has grown over the past two decades to a market valued at US$24 trillion4, including bonds issued in a variety of currencies.

That said, although the EM countries produce 50% of global GDP, they account for just 22% of global bond markets.3 The debt-to-GDP ratio is also much lower in EM countries than in developed ones; however, this has been growing as more EM debt gets issued.

Source: “The Emerging View, The EM fixed income universe version 7.0,” Ashmore, August 2018.

This shows there’s room for the EM bond market to grow. Conservative estimates have it growing to US$40 trillion over the next five years.3


To learn more about income investing, visit AGF.com. To find out how emerging markets fixed income could help diversify your portfolio, talk to your financial advisor.


1Source: “S&P Dow Jones Indices’ 2018 Country Classification Consultation” released June 13, 2018.

2Source: https://data.worldbank.org/indicator/ny.gdp.pcap.cd, 2017 data, source April 4, 2018.

3Source: “The Emerging View, The EM fixed income universe version 7.0,” Ashmore, August 2018.

4Source: JP Morgan, as represented by JP Morgan GBI-EM Broad Index.

The commentaries contained herein are provided as a general source of information and should not be considered personal investment or tax advice. Every effort has been made to ensure accuracy in these commentaries at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change investment decisions arising from the use or reliance on the information contained here.

The contents of this Web site are provided for informational and educational purposes, and are not intended to provide specific individual advice including, without limitation, investment, financial, legal, accounting or tax. Please consult with your own professional advisor on your particular circumstances.

AGF Management Limited (“AGF”), a Canadian reporting issuer, is an independent firm composed of wholly owned globally diverse asset management firms. AGF’s investment management subsidiaries include AGF Investments Inc. (“AGFI”), AGF Investments America Inc. (“AGFA”), Highstreet Asset Management Inc. (“Highstreet”), AGF Investments LLC (formerly FFCM LLC) (“AGFUS”), AGF International Advisors Company Limited (“AGFIA”), Doherty & Associates Ltd. (“Doherty”) and Cypress Capital Management Ltd. (“CCM”). AGFI, Highstreet, Doherty and Cypress are registered as portfolio managers across various Canadian securities commissions, in addition to other Canadian registrations. AGFA and AGFUS are U.S. registered investment advisers. AGFIA is regulated by the Central Bank of Ireland and registered with the Australian Securities & Investments Commission. AGF investment management subsidiaries manage a variety of mandates composed of equity, fixed income and balanced assets.

TM The “AGF” logo and ® “Sound Choices” are registered trademarks of AGF Management Limited and used under licence.

About AGF Management Limited

Founded in 1957, AGF Management Limited (AGF) is an independent and globally diverse asset management firm. AGF brings a disciplined approach to delivering excellence in investment management through its fundamental, quantitative, alternative and high-net-worth businesses focused on providing an exceptional client experience. AGF’s suite of investment solutions extends globally to a wide range of clients, from financial advisors and individual investors to institutional investors including pension plans, corporate plans, sovereign wealth funds and endowments and foundations.

For further information, please visit AGF.com.

© 2021 AGF Management Limited. All rights reserved.

Written by

Sound Choices

Sound Choices

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