Time for a Fresh Look at Emerging-Market Bonds | Lord Abbett
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Market View

In a world marked by low, or even negative, rates on government debt, investors continue to search for yield. Here’s one approach for them to consider.

Read time: 2 minutes

We believe several factors are poised to contribute to a positive environment for emerging markets in 2021, chiefly, the extraordinary liquidity measures provided by both the U.S. Federal Reserve (Fed) and central banks across developed and emerging markets. Amid the ongoing COVID-19 pandemic, these institutions have committed to providing continued, stimulative monetary policy in order to support the global economy through the crisis—and perhaps beyond 2021.

Of course, the massive global liquidity measures designed to keep economies afloat and maintain low interest rates and low volatility have also contributed to the record levels of negative-yielding debt at the end of 2020 (see Figure 1). Although the increase does signal demand for low-risk assets, we believe it will also intensify investors’ search for yield within the EM debt markets.

 

Figure 1. Globally, Negative-Yielding Debt Has Risen Significantly

Total global amount of negative-yielding debt outstanding, February 29, 2016–January 27, 2021

Source: Bloomberg. Data as of January 27, 2021. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Based on the Bloomberg Barclays Global Negative-Yielding Debt Index, which represents negative-yielding, global, investment-grade debt and includes treasury, government-related, securitized, and corporate bonds from emerging- and developed-markets issuers.

 

Attractive EM Debt Fundamentals

The exceptional policy response by the International Monetary Fund (IMF) and central banks enabled certain EM companies to withstand the blows of the pandemic. Many people may find it surprising that default rates following the March 2020 market tumult have been much lower than expected among EM corporate debt (see Figure 2). Overall default rates (as measured by the J.P. Morgan Corporate Emerging Markets Bond Index) are also forecast to remain below 3% in 2021. We view low current and expected EM corporate debt default levels as favorable.

 

Figure 2. Global Default Rates in Late 2020 Were Below Expectations

*Through November 24.
Source: J.P. Morgan. Data as of November 24, 2020 (latest available). F=Forecast. J.P. Morgan Corporate Emerging Markets Bond Index (CEMBI) is a market-capitalization-weighted index that tracks total returns of U.S. dollar-denominated debt instruments issued by corporate entities in emerging-market countries. CEMBI High Yield (HY) is the below-investment-grade subset of the CEMBI. “Quasis” is a term for quasi-sovereign bonds, which are corporate bonds in which the government owns a partial stake in the issuing company. Asia = CEMBI Asia. EM Europe = CEMBI Europe. Latin America = CEMBI Latin America. Middle East & Africa = CEMBI Middle East & Africa. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Forecast default rates are not guaranteed, and 2021 defaults may be higher depending on general market conditions and other factors that may affect particular countries, industries, or companies.

 

Sovereign EM debt fundamentals have been improving over a long period of time. Local currency markets have evolved, allowing for natural market forces to determine prices instead of pegged currency exchange rates. Stable currency exchange rates have significantly improved inflationary pressures in emerging economies, while promoting stability and growth. Central banks have also learned from previous financial crises and have adapted the use of their complete monetary policy tool kits, which further support EM sovereigns and provide access to capital previously limited during times of stress.

China on the Rebound

One of the most important factors influencing our outlook for EM debt in 2021 is the recovery in China. China has become the second largest economy in the world and is now more important to emerging-market growth than developed markets. China’s capacity to adapt economic activity during the pandemic has had a very positive impact on emerging-market economies that are dependent upon commodity exports to China. North Asian countries, such as China, South Korea, and Taiwan, have led the world in measures taken to reduce the spread of the virus and have also shown exceptional economic resilience. We believe the improved recovery profile in this region will provide a boost to fundamentals.

Summing Up

Our overall positive view toward EM debt is focused on external forces and EM debt-specific factors that we believe provide support to the asset class in 2021. These positive implications, however, are not uniformly anticipated across countries or regions. Challenges to vaccine penetration, significant debt burdens, and changing political landscapes are only a few reasons why we believe country, region, and security selection remain key to investing in the EM debt markets.

 

A Note about Risk: The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. High-yield securities, sometimes called junk bonds, carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. Bonds issued or guaranteed by non-U.S. governments and governmental entities (commonly referred to as ‘‘sovereign debt’’) present risks not associated with investments in other types of bonds. The sovereign government or governmental entity issuing or guaranteeing the debt may be unable or unwilling to make interest payments and/or repay the principal owed. Non-U.S. investments generally pose greater risks than U.S. investments. The securities markets of emerging-market countries tend to be less liquid, to be especially subject to greater price volatility, to have a smaller market capitalization, and to have less government regulation. Investing in non-U.S. denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be increased in emerging markets.

No investing strategy can overcome all market volatility or guarantee future results.

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This Market View may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize, or that actual returns or results will not be materially different from those described here.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future.

Glossary

Foreign Exchange (forex or FX): The trading of one currency for another. For example, one can swap the U.S. dollar for the euro. Foreign exchange transactions can take place on the foreign exchange market.

International Monetary Fund (IMF) is an international organization created for the purpose of promoting global monetary and exchange stability, facilitating the expansion and balanced growth of international trade, and assisting in the establishment of a multilateral system of payments for current transactions.

Bloomberg Barclays Index Information:

Source: Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices. Neither Bloomberg nor Barclays approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein.  If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in this Market View are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy and is not intended to predict or depict the performance of any investment.

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