Emerging Market Debt Becomes the Latest Hot Fund Sector
It's official: Emerging market debt is the next big thing. Investors have had a love-hate relationship with stocks in emerging markets for years, but fixed-income assets - bonds and other debt issued by governments and companies - in the developing world have remained a somewhat remote corner of the investment universe. Until lately.
The fund research firm Morningstar reported that flows into funds concentrating on emerging market debt have soared. Not only that, but activity has been especially great in funds that focus on debt issued in local currencies rather than dollars and euros and other denominations used in mature economies. That is a particularly esoteric segment of the global bond market.
A Pimco local-currency debt fund (PELAX) attracted $3.6 billion in new investment over a 12-month span, the Morningstar report pointed out, compared with $400 million for Pimco's equivalent hard-currency fund. Local-currency funds offered by Goldman Sachs (GAMDX) and Dreyfus (DDBAX) also have experienced strong inflows, according to Morningstar.
With such intense interest in something ordinarily so obscure, it's no wonder that Daniel Tenengauzer, a strategist at Bank of America Merrill Lynch who specializes in the sector, declared in a recent note to clients that "emerging markets fixed income is here to stay."
Emerging market government debt has produced a compound annual return of 11.2 percent since the start of 2001, compared with 5.5 percent for U.S. Treasury bonds and 7.9 percent for American high-yield corporate debt, Tenengauzer said in his report. Mutual funds that focus on emerging market debt have captured every bit of the sector's strong returns, rising at 11.6 percent a year for the last 10 years.
Tenengauzer explained the performance by pointing out that fiscal and economic conditions are far healthier for governments in many developing economies than in the West, a case that specialists in the field have been making for many years. Jerome Booth, head of research at Ashmore Investment Management in London, argues that emerging market debt will continue to outperform because the grand, collective balance sheet of the developing world will continue to improve relative to that of mature economies.
"Emerging markets, including and in particular their central banks, are massive creditors," Booth, who has one of the best long-term performance records in the field, told MoneyWatch. That means that holders of their debt instruments should get a positive double whammy from appreciating currencies and declining interest rates, compared to other types of debt, as more investors become wise to that superior creditworthiness.
Emerging market debt is not all that odd and esoteric, either, Booth added. Outstanding emerging market debt totals $9.2 trillion, he said, about 20 percent of the global total and more than the value of Treasury bonds if you remove from consideration the many billions sitting in the Social Security kitty.
So that means that investors should make it a priority to increase their exposure to the sector? Maybe, but don't rush in just yet. On Thursday, more on the case for owning emerging market debt plus a word of caution.
