Van Eck believes Australian institutional investors are under allocating to emerging market (EM) debt and that it should be considered a standalone asset class beyond global bonds where it has traditionally been grouped and poorly represented.
Eric Fine, Portfolio Manager of Van Eck’s unconstrained EM bond strategy, says many Australian institutions are gaining access to EM debt through a global bond strategy. “The problem with this approach is that global bond strategies do not provide optimal exposure to EM bonds because they have constraints that limit allocations or exclude certain EM debt sectors,” he says.
In a paper for Van Eck’s institutional clients, Why Emerging Market Debt Needs Its Own Allocation, Fine presents an efficient frontier analysis that suggests EM hard currency debt should have an allocation well above the EM debt exposure investors get in a typical global bond fund.
Contrary to conventional wisdom, Fine believes EM bonds may have similar if not superior liquidity compared to the US high yield and US investment grade bonds that dominate global bond funds. While he agrees illiquidity is a risk for EM corporate and sovereign debt, Fine says: “It is not clear illiquidity in EM debt is any greater risk relative to developed markets such as US high yield and investment grade debt.”
To maximise the opportunities in emerging market debt, Van Eck takes an unconstrained approach to EM hard currency, EM local currency, and EM corporate debt.
Fine’s modelling of historical returns from 2004 to 2015 shows EM debt delivered a higher premium to investors for the ‘same’ fundamentals as developed market debt. “The EM trend regression line has consistently higher spreads for hard currency debt and higher real yields for local currency debt than the spread and real yield for the same-rated developed market debt,” he explains.