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Charting Opportunity in Emerging Markets: Fixed Income Yields Look Compelling

The yawning gap between emerging market (EM) and developed market (DM) fixed income yields highlights continued opportunity in EM debt. Investors may want to adjust their allocations accordingly.

Investors who gave up on emerging markets in recent years missed out on a significant recovery, as both local and external EM debt indexes1 have gained around 10% over the past 12 months. While replicating such strong returns over the next year seems unlikely, EM local and external bonds may provide better yields than developed market alternatives, as the chart shows. Going forward, we expect developed market real yields to be capped by low potential growth and persistently high debt burdens.

Emerging markets’ resilience is creating an upward trend that investors have just recently started to price in to EM assets, and valuations appear attractive compared with DM bonds. The wide real-yield gap also means EM debt will likely be less sensitive to higher rates in developed markets.

Emerging markets do, however, remain vulnerable to a turn in risk sentiment, and our generally positive view on EM is not an “all-clear” signal. We recognize that risks persist, but believe they are much diminished now compared with the fourth quarter of 2016 and less likely to materialize over the next year.

In sum, while caution is warranted, we think now may be a good time for investors to consider adding diversified EM allocations to their portfolios.

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1JPMorgan GBI-EM Global Diversified and JPMorgan EMBI Global indexes.
The Author

Yacov Arnopolin

Portfolio Manager, Emerging Markets

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All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.

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