Good article!
https://www.tcw.com/News_and_Commentary/Market_Commentary/Insights/08-29-11_Emerging_Markets_Local_Debt-_The_Secular_Shift.aspxTCW Emerging Markets Insight
August 29, 2011
Blaise Antin , Jean-Charles Sambor
Emerging markets (EM) local currency bonds currently represent one of the most compelling opportunities in global fixed income. Recent uncertainties in the U.S. combined with the on-going European debt crisis have reinforced the case for a structural shift away from developed to emerging markets driven by the latter’s stronger fiscal accounts, balance of payments and debt metrics. The local currency (LC) market has expanded steadily during the past decade as both sovereign and corporate issuers look to borrow locally to reduce the volatility of their debt service and to satisfy a growing domestic institutional investor base. Local currency emerging markets debt (EMD) funds have enjoyed robust asset growth in recent years as the investable universe has expanded and liquidity has sharply improved, accounting for over 60% of the inflows into EMD mutual funds in recent years.
This growing asset class provides diversification benefits and an attractive risk/reward profile for both fixed income and multi-asset portfolios. Based on various portfolio optimization studies, the optimal share of EMD in a global fixed income portfolio could be as high as 60% with LC instruments accounting for over half of this allocation.
Comments
What you're misunderstanding is how it can fit in a portfolio. I wouldn't say to replace your high-quality bond allocation with EM bonds but what I can do is pare back some of my EM equities and use EM bonds as part of my overall EM allocation.
You get the opportunities to participate in the EM region that's not as aggressive as the EM equities. Also there are going to be times when a particular country's stock market might be a bit frothy to invest in after a wonderful 5+ year run but their juicy yielding debt might be a better investment RELATIVE to their equities. For example --- look at Brazil this year.
Also most of the EM stock funds tend to be Asia heavy and invest mostly in the biggest markets. I also like adding EM bonds because the country exposure can be quite different and therefore giving me a better EM balanced exposure.
For example --- some of the countries in the top 10 countries of DLENX (DoubleLine EM Bond Fund) include...Peru, Mexico, Argentina, Chile, Colombia, Peru, etc. Where are you gonna find that kind of exposure in any EM fund?
This addition gives me better balance because I have Matthews Asia Funds giving me dividends in Asia, Wisdomtree EM equities which are more Asia heavy as well as other funds with EM exposure which tend to be more Asia heavy such as Taiwan, South Korea, Hong Kong, etc.
Step out of the box and look at things with a 360 degree perspective.
David said it *VERY* well in this month's commentary: "PIMCO Developing Local Markets (PLMIX) has changed its name to PIMCO Emerging Markets Local Currency, presumably to gain from the “local currency debt” craze." A number of EM debt funds have sprung up over the last year or so to capitalize on the new trend.
This is not saying that one shouldn't own EM debt - not at all - in fact, I definitely think it should be a good part of a fixed income portfolio. However, this is not the time to jump into it heavily if you have not already done so.
Additionally, EM debt is potentially significantly volatile - while not as volatile as EM stocks, those who are conservative should take a look at EM bond funds in 2008, many of which lost around 15% and came down from the top quite quickly when the market started down (TGINX - 8/4/08 - $9.13; 10/20/08 - $6.69) - I will say that EM debt started to rebound in 2008 before the stock market did, but do be aware that that kind of price movement in a short time frame is entirely possible.
Additionally, a couple of additional points - I'd prefer EM corporate-heavy funds vs EM sovereign-heavy funds, and local currency bonds are a good non-dollar way to diversify to a point; that point being when one or more of these governments intervene in the currency markets, which has been seen more often lately with the kind of "currency wars" going on, and I think will be seen more frequently over the next year or two. Inflation will continue to be a concern in these markets, but I think it's going to be a worldwide concern over the next 5 years or more.
Additionally, while I did very well with EM in general a couple of years ago, I've reduced/altered overall allocation to it since and definitely do not plan at all to go back to the level of allocation that I had to it. I don't think the EM story is over (especially Asia), but I do feel the time to be heavily overallocated (and I was very heavily overallocated) to EM was 1-2 years ago.
On the other hand, I believe EM debt is over-priced having a narrow segment experiencing rather big inflows. However, EM debt might do well for a while more as long as inflow continues. Just like gold where production is limited to 1-3% growth annually, if more people pile on an asset that can be met by supply the price is going to rise. At some point, people getting in late will see losses. Are we at that point yet? I don't know.