US-based Payden & Rygel, a privately-owned global investment firm, has released a white paper assessing the benefits of investing in emerging markets debt through 2023.

Payden & Rygel, the Los Angeles-based investment house, says that investors should boost weightings in emerging markets debt through 2023.

According to the firm, emerging markets debt stands out as one place where investors can potentially take advantage of an underused asset class that offers attractive yields and diversification. 

In the current environment, EMD offers compelling valuations and an attractive long-run income opportunity, the emerging market team at Payden said.

The new white paper states that EM debt offers a better return per unit of risk versus EM equities. Over the past 20 years, the main EM equity index has approximately 2.5 times the volatility of the main hard currency EM debt indices (sovereigns or corporates), the paper adds. 

While EM equities have generated higher absolute returns over this time, when adjusted for volatility, EM debt returns are about 40 per cent higher than EM equities, it continues.

With these statistics in mind, Payden, which advises over $9.9 billion in EM debt strategies, considers that there is an under-allocation to the asset class.

Payden, which has over $137 billion under management, runs the Payden Emerging Debt Fund, which recorded net inflows in excess of $100 million in the past year. 

EMD in institutional portfolios is limited, the firm continued, and it sees about 4 to 6 per cent allocated to EMD. However, it believes that many institutions maintain a smaller (2 to 3 per cent) EMD allocation, and that many institutions have no exposure to the asset class.

Payden considers these weightings to be “modest,” given that sovereign and corporate dollar-denominated debt with EM local-denominated sovereign debt, totals some $6 trillion. This gives a sense of the EM investible universe and compares favorably to peer asset classes such as US high yield, the firm said.

In the current economic climate, one advantage of having EMs has been that many of the largest EM central banks started rate hiking well before the US Federal Reserve and other advanced economies, so this proactive central banking has benefited EMs. 

Payden notes, for example, strong performance in EM currencies in non-European EM currencies which have posted positive returns of 1.6 per cent against the dollar in 2022. It says, more specifically, that some of this has been driven by currencies in Latin America such as the Brazilian real, the Mexican peso, and the Peruvian sol.

Payden also underlines the importance of active management investment strategies to optimize returns in this sector.

The case for investing in emerging market debt in local currency toward the end of 2023 was also highlighted by Swiss private bank Lombard Odier in their outlook this week.