Relevant influences for EM bonds
Fundamental data, interest rate levels, and US yields
Bonds from the Emerging Markets are influenced by two factors above all. One is the fundamental state of the interest rate levels of the countries from which they originate and the other is the yield levels and movements of US government bonds. There is a difference here between EM bonds in local currency and those issued in hard currency (especially USD and EUR). The latter are very dependent on interest rate movements in the USA and in Europe. In general, currency movements (for the US dollar or Emerging Market currencies) can make a substantial contribution to any returns or value losses for euro-based investors. In 2023, this component usually played a comparatively minor role.
Hard-currency bonds
US yields set the tone
The vast majority of EM hard-currency bonds are issued in US dollar. They largely follow government bond yields in the USA and always trade at a more or less substantial yield premium over US government bonds. This yield advantage accounts for a large share of their attractiveness, but differs in magnitude for each country or issuer. It means not only possible returns in excess of those for US government bonds, but also a higher degree of risk.
A metric that summarises the entire tradeable market is the so-called EMBI spread. At present, it is listing at around 400 basis points. This means that hard-currency EM bonds are offering an average of around 4% more yield per year than US government bonds of the same maturity. In absolute terms, this is around 8% p.a., which is an attractive yield. All the more so considering that yields on the bond markets are expected to trend down around the world as the year progresses. This means that the current credit spread also compensates for possible default risks for some countries. These 8% only provide a rough point of reference for the actual annual returns, however. These are influenced by a large number of other factors (especially bond price movements) and can turn out to be higher or lower.
The acronym EMBI stands for Emerging Markets Bond Index. The EMBI spread is an indicator for the risk premium on Emerging Market bonds. It measures the yield difference between Emerging Market bonds and US Treasuries and is expressed in basis points. A higher EMBI spread means higher risk while a lower spread means lower risk.
Local-currency bonds
Yields and currency movements important
Local-currency bonds do not follow US yield movements as much, but are driven above all by the national economic and monetary policy environment. This especially includes the key rate of the respective central bank, the local inflation rate, and the financial situation of the respective country. For foreign investors, possible returns – or value losses in the case of negative developments – are influenced above all by the yield on these bonds and currency movements.
Careful selection and diversification are important
A very careful selection of countries and issuers and good diversification are indispensable for EM bonds (in hard and local currency), which makes investment funds with their diversified portfolios especially ideal.
Growth prospects for EM bonds in 2024
The growth outlook improved for most emerging countries recently. At the same time, retreating inflation and the downtrend in US bond yields should lend a boost to the local bond markets. The currencies are not expensive in most cases. However, if the global growth conditions deteriorate unexpectedly, this would be good for the bond markets – but experience has shown that such a constellation may put EM currencies under pressure. The yield on local-currency EM bonds is more or less in line with the long-term average, with considerable differences between individual countries.
Will international investors come back soon?
The positioning of foreign investors is positive for the market overall. Over the past years, they have steadily taken capital out of local-currency EM bonds. This means rather moderate risk for further capital outflows (and the attendant downside pressure on prices) and also brings upside potential in the event that foreign investors begin turning more to local-currency EM bonds.
Overall, EM bonds in USD or EUR are definitely offering attractive yields and a good risk-return profile at present. In the opinion of the investment specialists at Raiffeisen KAG, the current yields at least sufficiently compensate for the likely risks. This of course does not apply in the event of unexpectedly severe negative developments (e.g. economic development, inflation, or geopolitics).
Investing sustainably in Emerging Market bonds
For risk-conscious investors seeking to leverage the long-term earnings opportunities of EM bonds, Raiffeisen KAG offers two specialised funds that also invest according to sustainable criteria. This also supports the shift to more responsible business activities in the Emerging Markets.
Raiffeisen-Nachhaltigkeit-EmergingMarkets-LocalBonds invests in local-currency bonds whose issuers are classified as sustainable. In the case of countries that cannot be rated as sustainable, the fund covers the relevant currencies or countries by alternatively investing in bonds of supranational issuers. These include national and international development banks.
Raiffeisen-EmergingMarkets-ESG-Transformation-Rent, on the other hand, invests in Emerging Market bonds in hard currency while focusing on the sustainable development process. After all, the goal in the Emerging Markets is to approximate the ESG levels that are already taken as the minimum standards in many industrialised countries. With this in mind, the fund has the phrase “ESG transformation” in its name and consciously invests in issuers with (as yet) comparatively lower ESG ratings but that are clearly on the right path.
Find out more about the Emerging Markets and about the current developments on the capital markets.