Bonds issued by some of the world’s poorest countries have enjoyed a robust start to 2024, despite the backdrop of elevated US interest rates.
Over the first five months of the year, the JPMorgan EMBI Global Diversified index recorded a 3.5 per cent return in euro terms, outperforming broad bond indices of more developed markets. This performance is likely driven by a stronger-than-expected global economy and higher commodity prices, which benefit exporting countries such as Nigeria.
The resilience of these bonds is noteworthy. Typically, high bond yields in the US and Europe cause problems for developing countries, as investors, enticed by better yields closer to home, withdraw their capital. Morningstar data reveals that European investors pulled nearly €807 million from global emerging market bond funds in the first four months of 2024, compared to inflows of nearly €110 billion into bond funds overall.
Local currency bonds lagging
Emerging market local currency bonds have been less successful so far this year. Over the past decade, the JPM GBI-EM Global Diversified Index has delivered an annual return of just 1.6 per cent in euro terms, significantly below the 5 per cent return of the JPM EMBI Global Diversified index. This underperformance is mainly due to a strong US dollar. In the early 2000s, when the dollar was weaker, local currency bonds performed much better. Investors in bonds denominated in US dollars or other hard currencies are less concerned about currency fluctuations, seeking compensation primarily for higher credit risk.
The JPM EMBI Global Diversified is the benchmark for bonds issued by emerging market countries in foreign currencies. These bonds are typically from smaller and less developed countries that cannot issue sufficient government bonds in their local currency. Improved fundamentals, economic factors, and the emergence of local institutional market players have allowed bonds issued in ringgits, reals, rand, and other local currencies to meet the bulk of developing countries’ borrowing needs. Foreign participation also provides financing, increases liquidity, and helps reduce short-term foreign currency borrowing, a significant factor in previous crises during the 1980s and 1990s. Issuing debt in foreign currency exposes countries to exchange rate risks, making international debt repayment more expensive if the local currency depreciates.
Venezuela: a special case
Venezuela, a country frequently in the headlines, has dollar bonds in circulation despite its economic turmoil, characterised by defaults, skyrocketing inflation, and sanctions. While many view Venezuela’s debt situation as hopeless, some investors speculate on a potential debt restructuring, given the country’s substantial oil reserves. Venezuelan bonds rejoined the JPM EMBI Global Diversified index in April after US sanctions on secondary market trading were lifted in October. This inclusion could pave the way for Venezuela to raise international funds again. The benchmark index includes a range of countries, from investment-grade issuers like Kuwait and Uruguay to those with junk status, such as Turkey and Angola.
Morningstar’s Fund Radar
According to Morningstar analysts, the strategies that stand out possess a strong management team and a robust investment process. One such fund is Neuberger Berman Emerging Market Debt - Hard Currency, which offers long-term exposure to emerging market bonds while mitigating local currency risks. The fund is led by industry veteran Bart van der Made, supported by Rob Drijkoningen and Gorky Urquieta, with a combined experience of nearly 30 years. The team focuses on country selection and less-traded high-yield bonds, contributing positively to performance.
The fund’s investment process relies on bottom-up country selection with top-down beta management playing a secondary role. The managers aim to outperform the JPMorgan EMBI Diversified Index by about 1 to 2 per cent annually. They avoid local currency bonds and direct exposure to emerging market currencies, instead focusing on undervalued debt in lesser-known market segments. The fund has recently invested significantly in bonds from lower investment-grade issuers such as Côte d’Ivoire and El Salvador. Despite periods of underperformance, the fund rebounded strongly in 2023 and early 2024, aided by overweight positions in high-yield government bonds from countries like El Salvador, Argentina, and Sri Lanka.
Thomas De Fauw is manager research analyst at Morningstar. Morningstar analyses and evaluates investment funds based on quantitative and qualitative research. Morningstar is one of Investment Officer’s knowledge partners.