Michael Cirami, Co-Director of Global Income at Eaton Vance believes that investors tempted to increase EM exposure should carefully consider their investment approach now.
He added: “The start of 2016 has marked something of a comeback for emerging-market (EM) debt, which has advanced 13.4% for the year to date through April 20, based on the JPMorgan Government Bond Index-Emerging Markets (GBI-EM). This follows a difficult three-year stretch ending on December 31, in which the GBI-EM gave up almost a third of its value, hurt by sluggish global growth, falling commodities prices and a strong U.S. dollar.
“While a tail wind for the asset class is beneficial, we believe that investors tempted to increase EM exposure should carefully consider their investment approach.
“This is especially true given the expansion of the sector and the proliferation of EM indexes over the past two decades. For example, the first popular EM index – the JPMorgan Emerging Market Bond Index (EMBI) – was introduced in 1991 and comprised only government dollar-denominated debt. The GBI-EM followed in 2005 and comprises local currency sovereign debt. Today, the EM index set also includes proxies for corporate debt as well as lower-rated sovereign issuers.
“The newer indexes are useful in that they represent additional factors that can drive performance – foreign currencies, credit and lower-rated sovereign debt. However, investing in EM by allocating to indexes is essentially a top-down approach that, in our view, entails a number of drawbacks. For example:
- Managers must focus on macroeconomic “big things,” like U.S. Treasury yields and global monetary policy. Big things clearly affect EM prices, but with the whole world’s scrutiny, it is hard for EM managers to make money from them in a repeatable fashion.
- Index countries make up a limited universe that omits about two-thirds of the $32 trillion in GDP represented by emerging and developing markets, according to the IMF (see attached chart).
- At any given time, index countries are likely to be unattractive investments, based on valuation, creditworthiness or other metrics EM managers use.
We believe a better approach is to focus on the small things, with bottom-up evaluation of all EM countries – not just those in a benchmark. This approach includes country-level macroeconomic and political research, and stand-alone analysis of specific risk factors, like interest rates, currencies, and sovereign and corporate spreads.
Bottom line: Indexes may be helpful as references, but we believe that “staying small” offers the best way to unlock the potential of EM debt.