Emerging Market Fixed Income: Focusing on Flows

2013 was not a good year for performance in emerging markets (EM), emerging market fixed income or fixed income in general, outside of U.S. high yield. Interest rates rose, EM currencies generally weakened against the U.S. dollar, and investors were more upbeat about prospects in the developed world than those in the emerging world. While we will provide a more in-depth analysis of specific emerging markets in an upcoming blog post, we thought it might be useful to put 2013 in context of money flows to potentially understand where the market is positioned at the beginning of 2014. Simply put, when there are more sellers than buyers, prices tend to fall. At the most basic level, flows can be a driver of asset prices. According to J.P. Morgan, in 2013 flows into emerging market fixed income occurred at the slowest pace since the global financial crisis. All told, only $9.7 billion flowed into dedicated emerging market fixed income strategies last year, well below the $40 billion historical average run rate¹. On the WisdomTree front, the Asia Local Debt Fund (ALD), Emerging Markets Local Debt Fund (ELD) and the Emerging Markets Corporate Bond Fund (EMCB) had net inflows of only $84 million². However, some interesting and noteworthy trends emerged in 2013 for the asset class. The wide-scale redemptions of emerging market debt generally occurred from retail investors ($9 billion in outflows), whereas many institutional clients took advantage of the increase in relative yields to reduce structural underweights to EM debt. All told, institutional accounts accumulated an estimated $20 billion of emerging market debt in 2013³. In spite of the disappointing 2013 performance, there were a few additional bright spots that emerged from the emerging markets. Emerging market corporations came to market last year with a new record annual issuance of $359 billion⁴. Again, it was predominantly institutional investors that were taking down this record supply. In a trend we noted previously, we believe that the emerging market corporate asset class is only in the very early stages of adoption for many fixed income investors. In our view, a large number of emerging market corporate issuers took advantage of some of the lowest borrowing rates in their history to lock in financing last year, putting them on a much stronger footing to start 2014. J.P. Morgan projects that in 2014, net financing needs for EM corporations will fall 39%, to $143 billion⁵. Emerging Markets Fixed Income Overview For definitions of indexes in the chart, please visit our Glossary.   Looking to the year ahead, we believe that many of the same elements that drove 2013’s increased adoption of emerging market credits may hold. Namely, improving issuers’ credit profiles, shorter duration than EM USD sovereigns and attractive yield levels (read previous blog post here). Even though U.S. interest rates are currently forecast to rise this year, positioning in emerging market corporate debt tends to be much lighter than other fixed income sectors⁶. We believe that as developed world growth continues, many of the large, multinational EM corporations will stand to benefit. From a valuation perspective, investment-grade-rated EM issuers now have yields more in line with single-B-rated issuers in the U.S. and Europe⁷. While total returns may be dampened on account of rising U.S. interest rates, we believe that EM corporates are currently attractively priced against other similar credit quality assets.   ¹Source: J.P. Morgan, as of 1/8/14. ²Sources: WisdomTree, Bloomberg; as of 12/31/13. ³Source: J.P. Morgan. ⁴Source: J.P. Morgan. ⁵Joyce Chang, “Emerging Market Outlook and Strategy,” J.P. Morgan, 1/8/14. ⁶Source: J.P. Morgan, as of 1/8/14. ⁷Sources: J.P. Morgan, Standard & Poor’s; as of 1/8/14.