Investor demand for EM debt set to rise on diversification benefits and attractive valuations, survey shows

Diversification benefits and attractive valuations are the two main reasons cited by institutional investors for an anticipated rise in exposure to emerging market debt, according to the a survey by NN Investment Partners.1

More than half (54%) of respondents in the survey expect institutional investors to raise their exposure to the asset class over the next three years. Only 7% of respondents expect a decline. Three in five (60%) of those who believe there will be an increase say it is because of the diversification benefits of EMD and 56% say it is because valuations are significantly more attractive versus other types of bonds and justify the extra risk. Two in five (40%) say EM debt provides better risk-adjusted exposure in an environment of low economic growth.

The investors’ views tally with NN Investment Partners’ outlook on emerging market debt.

Marco Ruijer, Lead Portfolio Manager in the EMD Hard Currency team within the EMD Boutique of NN Investment Partners, commented: “The current favourable global liquidity backdrop underpinned by unprecedented central bank monetary policy leads us to believe that allocations towards EM debt will continue; driven by the attractive valuations, improving EM fundamentals and diversification benefits.”

In terms of diversification, the biggest benefit of EMD is ‘geographic’, which was cited by 52%. Other benefits mentioned include enhanced income generation (48%); improved credit risk exposure (46%); improved credit sector exposure (20%) and duration (14%).

Factors that will make EM debt even more attractive include a further break-up of the Europe Union (41%); Brexit (25%); a Federal Reserve rate rise (25%); a rise in US inflation (19%); and a rise in Eurozone inflation (15%). Investors’ greatest concerns about the asset class however include political uncertainty (43%); credit quality (42%); liquidity (27%); a China slowdown (23%); an increase in defaults (20%); rising interest rates (17%); rising inflation (17%); and a shortage of bonds (6%).

Marco Ruijer added: “The bond yields available in EMs are clearly attractive to investors, who have been heavily focused on seeking income for some time. As the global economy continues to improve, investors will invest more in the asset class as they gain ever more confidence in the creditworthiness of EM debt and see it as a great way to diversify away from developed markets. Nearly half (46%) of our respondents expect fundamental credit conditions to improve in EMs over the next two to three years versus 24% who expect a deterioration."

“However, our research shows investors do have some reservations about EM debt generally, with the majority (60%) saying it is risky to take a broad passive approach rather than adopting active asset allocation to stock-pick the best opportunities and control the risks elsewhere.”

On average, investors believe that 6% of a portfolio should be invested in EM debt and more than one in seven (15%) believe exposure should be over 10%.

Issuance of EM debt is expected to rise over the next three years, with 56% saying this. Only 8% anticipate a fall.