PIMCO believes emerging markets will continue to evolve and provide opportunities to enhance portfolio returns in coming years. Because investors demand higher interest rates for the money they lend to emerging market borrowers, yields on emerging market bonds may have the potential to be higher than those available on investments like cash or U.S. Treasuries. However, credit differentiation will remain critical to the goal of producing excess returns.
In addition to possibly offering higher yields, this asset class also has the potential to reduce the volatility of a diversified fixed income portfolio, because the returns on emerging market debt are not closely correlated with those of many traditional asset classes. Within the emerging markets, investing in local-currency bonds offers both additional diversification and potential currency appreciation as these economies mature.
Because of their size and rapid growth, emerging markets have become an integral part of the global fixed income investment landscape. Given the ongoing need for substantial amounts of capital in many emerging countries, they are expected to remain major issuers of debt securities, so the marketplace should continue to expand rapidly. Moreover, as the availability of emerging market information has improved, the investor base has broadened.
What Is an Emerging Market?
The emerging markets comprise those nations whose economies are considered to be developing--or emerging from underdevelopment--and usually include most or all of Africa, Eastern Europe, Latin America, Russia, the Middle East and Asia excluding Japan. Some are heavily dependent on commodity exports while others have extensive service and manufacturing sectors. Emerging market debt includes sovereign bonds—issued by governments—as well as fixed income securities issued by public and private companies in emerging market nations.
Companies and governments in emerging market nations can issue two distinct types of debt: external securities denominated in major currencies such as the U.S. dollar and domestic securities denominated in their local currencies. The benchmark JP Morgan Emerging Markets Bond Index Global (EMBI Global) tracks total returns for US dollar-denominated debt issued by 32 nations. (Please see the appendix for a list of these countries.) JP Morgan’s Emerging Local Markets Index Plus (ELMI+) tracks local-currency-denominated instruments issued by 22 governments.
Rating agencies publish sovereign ratings that indicate countries’ ability to meet their debt obligations. The most creditworthy emerging markets countries will receive investment-grade sovereign ratings, meaning that their debt is rated at least ‘BBB-‘ or ‘Baa3’ by Standard & Poor’s and Moody’s, respectively.
Although it may be convenient to lump emerging market debt together into a single broad category, it is far from a homogeneous asset class. Individual markets may have dramatically different growth prospects and risk factors. In the short run, that means one emerging country's or region's bonds may be performing poorly, while another's may be doing relatively well. Therefore, profiting from emerging market investments requires extensive analysis of the risk-versus-return profiles of individual emerging nation markets and issuers.
Conclusion
Emerging market bonds may provide higher yields than Treasuries and due to their low correlation with other asset classes, offer the potential for lower volatility through portfolio diversification. Although credit differentiation is an important factor to consider with regard to particular government or corporate issues, emerging market debt will continue to be an expanding fixed income asset class in the years to come as emerging nations and their investor base continue to grow.
JP Morgan Emerging Markets Bond Index Global (EMBI Global)
Market Cap Weights (%) as of August 31, 2005
|
Country |
Weight |
|
Argentina |
1.8 |
|
Brazil |
18.9 |
|
Bulgaria |
0.6 |
|
Chile |
1.7 |
|
China |
2.2 |
|
Colombia |
3.4 |
|
Cote d' Ivoire |
0.1 |
|
Dominican Republic |
0.2 |
|
Ecuador |
1.2 |
|
Egypt |
0.4 |
|
El Salvador |
0.8 |
|
Hungary |
0.5 |
|
Indonesia |
0.7 |
|
Lebanon |
1.6 |
|
Malaysia |
3.4 |
|
Mexico |
18.1 |
|
Morocco |
0.3 |
|
Nigeria |
1.0 |
|
Pakistan |
0.2 |
|
Panama |
2.2 |
|
Peru |
2.7 |
|
Philippines |
5.4 |
|
Poland |
1.2 |
|
Russia |
13.3 |
|
Serbia and Montenegro |
0.3 |
|
South Africa |
1.6 |
|
Thailand |
0.2 |
|
Tunisia |
0.3 |
|
Turkey |
7.4 |
|
Ukraine |
1.2 |
|
Uruguay |
1.1 |
|
Venezuela |
6.1 |
Source: JP Morgan