Lukas Strobl: Fixed income is back. That is, treasuries are back, once again yielding about as much as dividend stocks as central banks fight inflation with rate hikes, and investors seek havens amid global uncertainty. Now, in the world of higher-yielding bonds, the picture is a lot more differentiated. Morningstar's senior analyst, Elbie Louw, has looked into local currency emerging market bonds which have actually held up quite well. Elbie, why is that?
Elbie Louw: Hi, Lukas. Emerging market bonds denominated in local currencies have declined this year. But compared to losses in euro-denominated debt, their performance has been stellar. Compared to the 7.1% slide in the JP Morgan Global Bond Indexes Emerging Market Global Diversified Index with a 16% slump in the Bloomberg Euro Aggregate. That may surprise many, considering a decent chunk in the emerging market basket was debt from Russia, which has been a total write-off. This has been possible because, for one, many emerging markets started raising rates sooner and may be at the peak of their rate hikes already. Examples include Brazil and South Africa. Of course, that is in contrast to developed markets, where inflation is far from under control, and we can only speculate about when and at what levels these hikes will peak. Another big help has been strong internal growth in many emerging markets, especially in those where GDP is driven by commodities.
LS: But not all emerging markets are commodity powerhouses, and not all of them are done raising rates, right?
EL: True. Emerging markets is a bit of a mixed bag. Interest rates in China and Brazil have been positive contributors to emerging market bond price indices. In contrast, central European economies are extremely vulnerable to energy prices. So, those central banks will grapple with inflation for longer. As a result, we've seen significant price weakness in those bonds. Overall, the impact of local rates on a typical local-currency emerging market bond portfolio was negative. On the currency side, there's been a lot of headlines about emerging market currencies weakening. But from a European and U.K. investors' perspective, here again, things weren't quite so bad simply because the euro and the pound also weakened dramatically.
LS: Difficult waters to navigate. How are fund managers dealing with this?
EL: Well, there’s Kirstie Spence who manages the Capital Group Local EM Debt Fund-- she believes that some emerging markets are better at managing inflation compared to their developed-market counterparts. And generally speaking, the domestic economies of many emerging market countries are fairly healthy. Her team holds that inflation in Latin America might be close to its peak or have already peaked. In other countries, such as South Africa, that's a contrast to developed markets. The management duo of Antoon de Klerk and Werner Gey van Pittius, portfolio managers of the Morningstar Silver-rated Ninety One Emerging Markets Local Currency Debt Fund, say that the fundamentals of emerging markets continue to be relatively sound with attractive valuations. The team was slightly overweight the Mexican peso and Indonesian rupiah at the end of October 2022. Meanwhile, the Bronze-rated Barings Emerging Markets Local Debt Fund was positive on South Africa and Mexican local debt with 15.3% and 12.4% exposure, respectively, versus the benchmark's allocation of 10% each. The team there also favored South Africa for effective management of inflation, governments being able to meet its fiscal targets.
LS: Sounds like they're all managers who share your view on where emerging markets debt could be attractive right now. Thank you for these insights, Elbie. For Morningstar, I'm Lukas Strobl.
