Opportunities in emerging market debt
A troubled investment environment has made the hunt for elusive returns all the more pressing. Richard Garland of Investec Asset
Management outlines how emerging market debt can help captives achieve their investment ambitions.
and India continues rapidly, investors seeking to capture this growth and improve the risk-return profile of their portfolios are increasingly looking beyond traditional developed market equities and bonds to a newer asset class that has delivered surprisingly attractive risk-adjusted returns: emerging markets debt (EMD).
S To put the returns generated by EMD into context, particularly in light
of today’s background of low developed market yields, over the past 10 years locally denominated EMD has delivered average annual returns of 12.4 percent—almost double those generated by global bonds, and with half the volatility of emerging market equities over the same period (see Table 1 opposite).
We consider three questions on the asset class: (i) what is the long-
term strategic case for investing in EMD?; (ii) what is the outlook ahead?; and (iii) how could an allocation benefit an investment portfolio as a whole? How captives can access the asset class in light of regulation such as Solvency II equivalence is also discussed.
What is the long-term opportunity for investing in EMD?
For investors looking to access emerging markets against today’s background of low yields from developed markets, the returns from various types of EMD—both in terms of absolute return and Sharpe Ratio (a reward:variability ratio)—have delivered compelling risk-
ince the onset of the global financial crisis in 2007-8, emerging markets have attracted more than their fair share of headlines as being the place to invest for significant long-term growth. As the development of emerging markets such as Brazil, China
adjusted long-term performance versus a broad basket of investment assets. Combined with the rapid pace of development in EMD and currencies, this has led many investors to consider their first active allocation.
The emerging market universe encompasses more than 140 countries.
Over the past few years the debt issued by emerging countries and, more recently, companies within these countries, has begun carving out a niche for itself as a strategic asset class. Initially investments were largely confined to the debt issued by emerging market governments in hard currency (in other words, denominated in US dollars or euros), known as ‘hard’ EMD. Here the yields earned by investors and any subsequent capital gains or losses are driven primarily by the ‘credit story’. More recently, however, investors have begun to recognise an attractive, complementary investment to hard currency-denominated government debt in the form of local currency EMD (denominated in the currency of the issuer).
About one third of the countries within the total emerging markets universe have investable local currency debt markets. One key advantage of investing in locally denominated EMD is that investors may access returns from two sources: bonds and currencies. Therefore, investors gain exposure to attractive local yield relative to developed
42 bermuda captive 2012
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