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Investor demand for EM debt set to rise on diversification benefits and attractive valuations, says survey

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Diversification benefits and attractive valuations are the two main reasons cited by institutional investors for an anticipated rise in exposure to emerging market debt, according to a survey by NN Investment Partners.

More than half (54 per cent) of respondents in the survey expect institutional investors to raise their exposure to the asset class over the next three years. Only 7 per cent of respondents expect a decline.
 
Three in five (60 per cent) of those who believe there will be an increase say it is because of the diversification benefits of EMD and 56 per cent say it is because valuations are significantly more attractive versus other types of bonds and justify the extra risk.
 
Two in five (40 per cent) say EM debt provides better risk-adjusted exposure in an environment of low economic growth.
 
The investors’ views tally with NN Investment Partners’ outlook on emerging market debt.
 
Marco Ruijer (pictured), lead portfolio manager in the EMD hard currency team within the EMD boutique of NN Investment Partners, says: “The current favourable global liquidity backdrop underpinned by unprecedented central bank monetary policy leads us to believe that allocations towards EM debt will continue; driven by the attractive valuations, improving EM fundamentals and diversification benefits.”
 
In terms of diversification, the biggest benefit of EMD is ‘geographic’, which was cited by 52 per cent. Other benefits mentioned include enhanced income generation (48 per cent); improved credit risk exposure (46 per cent); improved credit sector exposure (20 per cent) and duration (14 per cent).
 
Factors that will make EM debt even more attractive include a further break-up of the Europe Union (41 per cent); Brexit (25 per cent); a Federal Reserve rate rise (25 per cent); a rise in US inflation (19 per cent); and a rise in Eurozone inflation (15 per cent).
 
Investors’ greatest concerns about the asset class however include political uncertainty (43 per cent); credit quality (42 per cent); liquidity (27 per cent); a China slowdown (23 per cent); an increase in defaults (20 per cent); rising interest rates (17 per cent); rising inflation (17 per cent); and a shortage of bonds (6 per cent).
 
Ruijer adds: “The bond yields available in EMs are clearly attractive to investors, who have been heavily focused on seeking income for some time. As the global economy continues to improve, investors will invest more in the asset class as they gain ever more confidence in the creditworthiness of EM debt and see it as a great way to diversify away from developed markets. Nearly half (46 per cent) of our respondents expect fundamental credit conditions to improve in EMs over the next two to three years versus 24 per cent who expect a deterioration.
 
“However, our research shows investors do have some reservations about EM debt generally, with the majority (60 per cent) saying it is risky to take a broad passive approach rather than adopting active asset allocation to stock-pick the best opportunities and control the risks elsewhere.”
 
On average, investors believe that 6 per cent of a portfolio should be invested in EM debt and more than one in seven (15 per cent) believe exposure should be over 10 per cent.
 
Issuance of EM debt is expected to rise over the next three years, with 56 per cent saying this. Only 8 per cent anticipate a fall.

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