The benefits Aussies gain from EMD
It can be worthwhile for advisers to consider a standalone allocation to emerging market (EM) debt, according to Ninety One.
In a report from the asset manager revisiting the case for EM debt, it said Australian investors have a natural advantage over those from other developed markets for currency reasons.
EM debt also offers an attractive entry point and significant yield pick-up relative to Australian fixed income assets.
“The strong US dollar has been a major tailwind to EM asset class returns over the past 10 years. Weakness in EM spot rates against a strong dollar took a particularly heavy toll during the taper-tantrum years (2013–16) and then again in the COVID crisis (2020).
“Australian investors are in an advantageous position compared to other developed market investors as the Australian dollar acts as a natural hedge for Australians investing in emerging markets given its relatively high correlation.
“Over periods of negative returns from EM debt (as measured in USD), the Australian dollar has delivered even worse returns. Thus, once translated into Australian dollar, EM debt will have delivered positive returns.”
Hedging the US dollar exposure in EM debt has also historically reduced drawdowns for Australian investors, and drawdowns have been largest when the EM debt portfolio is either entirely unhedged or 100 per cent hedged.
“Historically, by increasing the hedged portion of the portfolio, investors would have been able to increase returns on the portfolio. At the same time, as the hedge ratio increases towards 50 per cent, the volatility of the portfolio drops. However, above 50 per cent, volatility begins to rise again – which makes sense as above 50 per cent the hedge begins to negate the positive effect of investing in EM local currency debt from Australian dollars.”
Ninety One also noted EM debt is emerging from difficulties previously caused by COVID-19 and the war in Ukraine which has resulted in a much clearer outlook for investors.
“EM fiscal deficits have followed a relatively stable path in recent years, in contrast with developed markets, where policymakers had more room to unleash support/stimulus measures. Furthermore, the EM versus DM economic growth differential is improving again, after dropping around the COVID crisis as frontier market policymakers had much less scope to provide fiscal and monetary support.”
AUTHOR
Laura Dew
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