Strong investment case brewing for emerging markets in 2021

The recovery in emerging markets that picked up steam in the last six months thanks to Covid vaccine breakthroughs – and the weaker dollar – paints a bright picture for emerging debt markets in the year ahead

Strong investment case brewing for emerging markets in 2021
Strong investment case brewing for emerging market bonds as investors look beyond Covid. Photo: Reuters

(ATF) What's good for the global equity markets is even better for emerging markets (EMs). And as the EMs recovered smartly in the last three months of 2020, on par with both US equities and the broader developed markets (DMs), 2021 could well be the year for EMs as an asset class, according Rajeev De Mello, an experienced bond investor and managing director at Deep Learning Investments Pte. Ltd.

What’s more, with the MSCI Emerging Markets Index outperforming the MSCI World Index, representing developed markets, cyclical recovery in global markets, a weaker dollar, and very low interest rates in the US, a perfect concoction is also brewing for emerging markets debt in the year ahead.

“Investors globally are keen to invest, meaning there's a theme that we're getting to the end of the pandemic, even though cases are rising unfortunately. There is really hope with the vaccine being rolled out. And we're in the process of vaccination. So that's very positive. And that's helpful for global growth,” De Mello told Asia Times Financial-TV.

“And what's good for global growth is definitely good for emerging markets assets generally.”

The MSCI Emerging Markets Index outperformed the MSCI World Index, representing developed markets, in the last three months of 2020, with a return of 19.7% compared with 14.0%. Notwithstanding this year’s pandemic and lockdowns around the world, emerging markets equities also outperformed for the year – 18.3% versus 15.9%.

But stressing on bonds, De Mello says that following Fed’s strategy to support the US economy with near-zero interest rates: “Investors are not comfortable owning negative yielding bonds (in the US) for too long. So, they've got to go and take risk elsewhere. (Given that) the Federal Reserve (Fed) of the US (is expected) to stay low for a long time, investors are going to be pushed into all kinds of bonds.”

IMPRESSIVE RECOVERY

Undoubtedly, after an eventful and challenging year, emerging markets debt investors have much to look forward to in 2021, as all segments of this sub-asset class witnessed impressive recovery in the past three months.

Emerging markets corporate bonds, for instance, led the way with a return of 7.13%, owing to the strong balance sheet positions of corporates and significant outperformance during the depths of the crisis.

Hard currency sovereigns returned 5.26%, benefiting from a longer duration profile amid a drop of 100 basis points (bps) in US Treasury yields. Meanwhile, local currency debt registered a gain of 2.69%, thanks to a strong fourth quarter rally in emerging markets currencies.

INVESTMENT STRATEGY

Nevertheless, highlighting a risk to his positive outlook on EMs, De Mello also warns that default rates will continue to rise in China and EM bond investors must factor that risk in their investment strategy.

“In the last couple of years, China has really wanted to introduce more market mechanisms into the credit scene… (so) default rates (in China) will continue to rise at a controlled rate,” he says.

“Investors have to get used to a higher default rate. I think a lot of it is priced in already. And so I'm not so worried that it will contribute to a systemic risk to the credit market in China. But of course, investors have to be careful. But yes, investors should expect a gradual rise in default rates,” he added.

Also on ATF:

EM local bonds appeal with attractive yields and cheap currencies

Rising currencies spark fear of post-Covid currency war

 

Emerging Markets China Debt Default Rajee De Mello MSCI Emerging Market Index Weak Dollar