By Fran Rodilosso, Head of Fixed Income ETF Portfolio Management, and William Sokol, Director of Product Management
A favorable technical picture, combined with the attractive fundamental profile of emerging markets debt could lead to another year of potential outperformance versus developed markets bonds.
Emerging markets (EM) debt, in various forms, posted admirable returns in 2023. The most commonly cited form – US dollar denominated sovereign debt – benefited from the late year rate rally and posted a total return of +11.1% for the year. That was more than 550 basis points (bps) better than US aggregate investment grade bonds, 270 bps better than investment grade US corporates, and approximately 700 bps better than intermediate Treasuries. EM local currency sovereign bonds did even better than dollar-denominated sovereigns, outpacing the other asset classes listed above by an additional 160 bps, and without the benefit of a sustained EM currency rally. EM US dollar denominated corporate bonds did not fare as well as sovereigns overall, and both the investment grade and high yield components lagged their US corporate counterparts, but both still enhanced returns as satellite additions to core bond allocations.1
Given the higher yields available in EM and, in aggregate, stronger debt fundamentals versus DM counterparts, the overall outperformance in 2023 (and over the entire two-year period of 2022 and 2023) is not surprising. What might be surprising is that EM debt funds suffered consistent outflows throughout both 2022 and 2023. Flows out of dedicated hard currency EM debt funds were $45 billion in 2022 and $25 billion in 2023, while dedicated local currency debt funds saw outflows of $45 billion in 2022 and $9.0 billion in 2023. At the same time, net supply of EM dollar denominated sovereign and corporate debt shrank as well. Net new issuance in EM dollar sovereigns was only $21 billion in 2023, after registering -$28.6 billion in 2022. For EM dollar denominated corporates the numbers were -$157 billion in 2023 and -$259 billion in 2022. As the EM debt universe continues to mature in a variety of ways, apparently another important development is that outperformance is no longer driven exclusively by “hot money” flows. In fact, 2023 appears to have been a year of outperformance that was also characterized by an improving technical picture.
EM Debt Dedicated Cumulative Flows (US$, bn)
Source: EPFR, Morgan Stanley Research.
Both US high yield and municipal bond asset classes also witnessed net outflows in 2023, but US Treasury and Aggregate funds experienced significant inflows, particularly into ETFs, representing the majority of some $220 billion that came into taxable bond funds. That number does not include money market funds, which took in nearly $1 trillion in 2023! We believe that the favorable technical picture, combined with the attractive fundamental profile of EM debt, sets the stage for another year of potential outperformance versus DM bonds. Investors who are under-allocated to the asset class may want to consider increasing their exposure within their global bond portfolio.
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Originally published 8 February 2024.
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1 EM hard currency sovereign bonds represented by the J.P. Morgan EMBI Global Diversified Index; EM local currency sovereign bonds represented by the J.P. Morgan GBI-EM Global Diversified Index; EM corporate bonds represented by the CEMBI Broad Diversified Index; aggregate investment grade bonds represented by the ICE BofA US Broad Market Index; US corporate bonds represented by the ICE BofA US Corporate Index; Intermediate treasuries represented by the ICE BofA 1-10 Year US Treasury Index; US high yield corporate bonds represented by the ICE BofA US High Yield Index.
ICE BofA Diversified High Yield US Emerging Markets Corporate Plus Index: is comprised of U.S. dollar-denominated bonds issued by non-sovereign emerging markets issuers that are rated below investment grade and that are issued in the major domestic and Eurobond markets.
ICE BofA US Broad Market Index: tracks the performance of US dollar denominated investment grade debt publicly issued in the US domestic market, including US Treasury, quasi-government, corporate, securitized and collateralized securities.
ICE BofA US Corporate Index: tracks the performance of US dollar denominated investment grade rated corporate debt publicly issued in the US domestic market.
ICE BofA US High Yield Index: tracks the performance of U.S. dollar-denominated below investment grade corporate debt publicly issued in the U.S. domestic market. Qualifying securities must have a below investment grade rating. Original issue zero coupon bonds, 144a securities, both with and without registration rights, and pay-in-kind securities, including toggle notes, qualify for inclusion.
ICE BofA US Treasury Index: tracks the performance of US dollar denominated sovereign debt publicly issued by the US government in its domestic market.
J.P. Morgan EMBI Global Diversified Index: tracks USD-denominated emerging markets sovereign bonds. The weighting scheme provides additional diversification by more evenly distributing weights among the countries in the index.
J.P. Morgan GBI-EM Global Core Index: tracks bonds issued by emerging markets governments and denominated in the local currency of the issuer. The weighting scheme provides additional diversification by more evenly distributing weights among the countries in the index. Countries are capped at 10% and floored between 1% to 3%.
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An investor cannot invest directly in an index. Returns reflect past performance and do not guarantee future results. Results reflect the reinvestment of dividends and capital gains, if any. Certain indices may take into account withholding taxes. Index returns do not represent Fund returns. The Index does not charge management fees or brokerage expenses.
Information has been obtained from sources believed to be reliable but J.P. Morgan does not warrant its completeness or accuracy. The Index is used with permission. The index may not be copied, used or distributed without J.P. Morgan’s written approval. Copyright 2023, J.P. Morgan Chase & Co. All rights reserved.
There are inherent risks with fixed income investing. These risks may include interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond. When interest rates rise, bond prices fall. This risk is heightened with investments in longer duration fixed-income securities and during periods when prevailing interest rates are low or negative.
Emerging Market securities are subject to greater risks than U.S. domestic investments. These additional risks may include exchange rate fluctuations and exchange controls; less publicly available information; more volatile or less liquid securities markets; and the possibility of arbitrary action by foreign governments, or political, economic or social instability.
All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future results.
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