Fixed Income

EMD Relative weekly notes

Week Ending July 15, 2016


James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

In this era of unprecedented asset price movements, we think investors would be well served not to think of emerging markets as emerging markets.

Fixed income in developed markets has become, nearly quite literally, reward-free risk. With that unprecedented development, the only distinction to make that truly serves to clarify thinking is where the highest probability of achieving sustainable income lies—clearly, that probability lies outside of Europe, Japan, and the United States government bond complex. 

The sheer size of that complex means that as investors intensify the search for income and find alternatives, flows will cause yields to come down within those alternatives. The past two weeks of record inflows into EM mutual funds suggests this phenomenon is well underway.

The entire history of this asset class has shown that when markets respond in this way, risks come down. Foreign exchange reserves rise and currencies stabilize or appreciate, leading to lower domestic interest rates. This in turn causes funding costs to fall and debt to be re-financed at more attractive levels, causing growth prospects to rise as a result of all of this.  

Because of this virtuous cycle, investors and potential investors who attempt to divine "how far markets have run" or where "fair value" is are investing by guessing. We have seen this again and again over 26 years in emerging markets. The only successful approach in our opinion is to watch historically reliable indicators that confirm if the positive trends remain and to follow them as long as they do. Meanwhile, it makes sense to hoard attractive income opportunities that are already held.  

The only difference in the current cycle is the absolutely unprecedented nature of the potential flow size given the destruction of income opportunities by global developed market central banks. So it is reasonable in our view to postulate that historical valuation measures will prove poor indicators and emerging market income opportunities will continue to look very attractive. 

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.