Yields in emerging market bonds have another 3% to go, adding on top of the current 6% yield that the asset class is offering, says BlackRock.
Speaking at a briefing on Thursday, Sergio Trigo Paz, Blackrock’s head of emerging market fixed income said value of emerging market bonds will reach a peak in June. This suggests that price of emerging market bonds will start falling afterwards and yields will start to rise. He says investors have the second half of the year to “grab income” in the asset class and he sees another 3% in yield to go, on top of the 6% yields currently offering in emerging market bonds.
“Green Shoots” in Emerging Market Bonds
In terms of specific countries, Trigo Paz has an overweight allocation in Russia, Brazil and Indonesia. He holds a more negative view on Eastern Europe as he expects inflation in the region to rise and start eating away at returns.
“From a fundamentals point of view, things started to stabilise in some countries and you are paid for the risk you are taking, especially in Brazil,” he says. “We have started to see green shoots.”
Trigo Paz says Brazil is in a “deep recession” but is “healing”. The country is now running a current account surplus following an increase of capital reverses, which empowers Brazil’s central bank to control its currency, lowering the probability of a major currency blow up.
China: An Economic Turnaround
China is also high on Trigo Paz’s “green shoots” list of emerging markets to watch. While China’s economy situation started to turn around from last August selloff thanks to the stimulus, this world’s second largest economy by GDP is a huge driver of soft and hard commodities in emerging markets.
Neptune’s chief economist James Dowey agrees, saying last week to Morningstar that threat of China has abated since the beginning of the year.
“The Fed now takes China into account when deciding policy,” he said. “And China is working through its debt problem. We believe China has the tools to fix their problems.”
High Yields Drive Heavy Inflows in Emerging Market Bond Funds
As interest rates among developed markets fall even lower, the desire to escape negative yields drove “cross-border flows”, according to Stephen Cohen, global head of fixed income beta at BlackRock.
“As rates go lower, trying to find yield by extending duration is running out of steam," he said.
Owen Murfin, co-lead manager for global bond strategies at BlackRock agrees, suggesting investors look for attractive international opportunities, including US investment-grade bonds, mortgage bonds and emerging market bonds.
Trigo Paz added emerging market bonds add diversification in investors’ portfolios.
As the US currency starts to stabilise thanks to more certainty over the date of an interest rate hike by the Federal Reserve, it also will become a tailwind for inflows. A more stable oil price also contributes to inflows as the Organisation of the Petroleum Exporting Countries’ talks on oil production controls is ongoing, says Trigo Paz.
Inflows of global emerging market bonds have grown from £7 million in February 2016 to £31 million in April 2016, according to Morningstar Direct.
Who is Buying Emerging Market Debt?
Unlike February when investors were in a panic mode to buy emerging markets, Trigo Paz now sees a wide range of investors buying emerging market bonds in May.
“We see pension funds, institutional and retails clients that are in negative interest rates coming into emerging market bonds,” he adds.
This include the UK government run default pension scheme NEST, which runs pension plans for more than 69,000 companies with a total of 2.8 million employees. In March, the pension provider first included emerging market bonds in their multi-asset portfolios despite the asset class are widely considered more risky than their developed market counterparts.
