Investec Asset Management
Table 1: Correlation of investment returns with local EMD Annual return
Standard deviation
EM equities Local EMD
Blended EMD
Developed property
Global high yield Dollar EMD
Global equities Corporate EMD EM currencies S&P500
Hedge funds Global bonds Global credit US bonds
Commodities
17.9% 12.4% 11.5% 10.8%
10.7% 10.5% 8.3% 8.2% 8.0% 7.3% 7.2% 6.3% 6.1% 4.8% 3.6%
24.6% 12.0% 9.9%
22.7%
11.7% 9.1%
16.5% 9.0% 8.0%
15.1% 6.0% 7.4% 6.3% 4.9%
25.5%
Sharpe ratio
0.73 1.04 1.16 0.48
0.91 1.16 0.50 0.91 1.00 0.49 1.19 0.85 0.97 0.98 0.14
Correlation with local EMD
0.79 1.00 0.96 0.71
0.72 0.78 0.76 0.72 0.94 0.68 0.66 0.56 0.64 0.11 0.38
Data from December 31, 2002–March 31, 2012, standard deviation and correlation of monthly returns in USD, Local EMD = JP Morgan GBI EM Global Diversified. Blended EMD = 50% JP Morgan GBI EM GD+50% JP Morgan EMBI GD; Dollar EMD = JP Morgan Emerging Markets Bonds Index EMBI GD; Developed property = S&P/Citi Developed REIT Index TR; Hedge funds = CS/Tremont Hedge Fund Index; EM currencies = JP Morgan Emerging Local Markets ELMI Plus Composite; Global high yield = Merrill Lynch Global High Yield Index (100% hedged to $); EM equities = MSCI Daily Gross Returns USD EM; Global equities = MSCI Daily Gross TR USD World Index; Global credit = Citigroup World Broad Investment- Grade Index; Global bonds = Citigroup WGBI All Maturities USD; US bonds = Citigroup US GBI All Maturities USD; Commodities = S&P GSCI Total Return.
debt markets, plus the potential for capital returns as the yields of individual emerging market countries compress to levels more typical of the developed world. In addition, there is the potential for return from currency appreciation as emerging markets travel the path from emergence to development.
Bonds and currencies tend to react differently to changes in the economic cycle. Local yields are mostly driven by local macro-economic factors such as inflation, monetary policy and demand and supply of government bonds; emerging market currencies are typically driven more by fundamental and flow factors, such as trade and portfolio flows. This provides investors with the benefit of two diverse sources of return within one strategy, and this duality is a factor in contributing to both attractive returns and the lower volatility of potential returns for investors. In the landmark year of 2008, for example, local bonds posted positive returns due to their favourable reaction to lower inflation, slower growth and central bank rate cuts, yet currencies struggled in the risk- averse environment.
There are additional attractions to local EMD in that it now has a higher average credit rating (BBB+) than hard EMD (BBB-) as countries in the local EMD index have better liquidity characteristics than their hard currency equivalents. This reflects the progress made by many
emerging markets in reforming their local financial sectors in recent years, underpinned by strong banks, insurance companies and pension funds. The growth of institutional investment in emerging markets has produced a steady source of local demand and reduced dependence on volatile, external investment flows.
Over the past 10 years the issuance of local currency denominated
EMD has been significant. In June 2006 total outstanding local EMD in the market was around US $500 billion, and is now worth around $1.6 trillion. This expansion has been largely driven by many new emerging markets issuing debt in local currency for the first time, as well as capital appreciation over the period. Meanwhile, the total assets managed against local EMD indices by stand-alone local EMD asset managers has reached $125 billion, though this still lags behind the $227 billion managed against US dollar denominated ‘hard’ EMD.
What is the outlook for EMD? In recent years local EMD has delivered strong returns, but what does
the future hold? We are strong believers that emerging markets are in an excellent position to outperform developed markets for several years to come. Fundamentally, we believe that emerging markets have significant potential for strong growth coming from a lower base than
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