Kristin Ceva, managing director at Los Angeles-headquartered asset manager Payden & Rygel discusses why emerging market debt is an attractive opportunity for 2023. 

After a difficult 2022, emerging markets debt offers the potential for attractive yields and diversification in 2023, Kristin Ceva (pictured) at Payden & Rygel, said this week.

Investment portfolios are currently under-allocated to this asset class, with institutional portfolios holding around 4 per cent to 6 per cent of their assets in emerging market debt. Ceva believes that investors may wish to rethink their positioning in 2023.

“The asset class represents a large and growing proportion of the world economy, accounting for about 60 per cent of global GDP in 2022 (in PPP – Purchasing Power Parity – terms),” she said.

“Emerging markets debt also offers attractive yields,” she added. “As of the end of May 2023, emerging market sovereign yields are 8.6 per cent, emerging market corporate yields are 7.5 per cent, and emerging market local yields are 6.5 per cent, though with significant dispersion; several countries offer 8 to 12 per cent local yields.”

Ceva also believes that emerging markets debt isn’t as risky and underdeveloped as many investors believe: “About 60 per cent of the sovereign dollar-pay index is investment grade, and the percentage is even higher among emerging markets corporate bonds (67 per cent) and local currency bonds (75 per cent).” 

“Emerging market debt also delivers greater diversification benefits compared to emerging market equity, and with much lower volatility,” she said. “Consider that while emerging market equities have generated higher absolute returns, when adjusted for the volatility, emerging market debt returns are about 40 per cent higher than emerging market equities.” 

“The largest emerging market sovereigns and corporates have also been resilient in the face of rising rates and tighter financial conditions,” she added. “This is because central banks got ahead of inflation with proactive rate hikes, and corporate balance sheets have been well-managed.” 

Ceva highlighted that emerging market local interest rate and currency markets are particularly compelling in the current environment. This is due to high emerging market rates, reflecting proactive EM central banks, as well as decelerating inflation momentum and the US Fed nearing the end of its hiking cycle. It is also due to a long run of the dollar’s strength leading it to overvalued territory and relatively resilient emerging market growth amid a likely US slowdown, she said.

China
Ceva believes that China will need to stimulate the property sector more aggressively, given the continued weakness in the space and the fact that it accounts for 25 per cent of China’s GDP. This has been highlighted by other investment managers. See here. “However, the timing on this is not easy to call given Xi’s reluctance to lose the progress they’ve made in tackling the moral hazard issue of bailouts.  The government needs to create more confidence in property developers and do more to improve home sales,” Ceva said. 

“China’s slowdown will impact the rest of emerging markets in different ways than it has in the past due to its ongoing transition from a manufacturing-oriented economy to a services-led economy,” she continued. “It will be less impactful than in the past to commodity-exporting countries, and more impactful to trade-oriented countries, particularly in Western Europe, that export to the Chinese consumer sector.” 

“In addition, China’s very low stocks of commodities have led it to re-stock and potentially stockpile, so China’s slowdown has not had a large commodity effect. Current activity indicators show EM-ex China growth to be strong and improving versus developed country growth,” Ceva concluded. The case for investing in emerging market debt has also been highlighted by other investment managers.

With $144.4 billion under management, Payden & Rygel’s clients include central banks, pension funds, insurance companies, private banks and foundations, with offices in Los Angeles, Boston, London, and Milan.