State Street SPDR: Emerging market debt, hard currency for hard markets
Against a challenging backdrop for fixed income, emerging market debt is one area where investors can take on some risk. High yields and portfolio diversification help to make this a compelling exposure within fixed income. That states State Street SPDR in a commentary on the markets.
However, given persistent US dollar strength, a hard currency approach to emerging market debt makes sense for the near term.
For those investors who cannot see an imminent catalyst for a weaker USD, then exposure to hard currency EM debt can offer an alternative option to increase the yield and diversify the portfolio.
Defensive duration positioning
Maturity constraints mean that the option-adjusted duration on the ICE BofA 0-5 Year EM USD Government Bond ex-144a Index is just 2.55 years. This is less than half that of the JP Morgan EMBI Global Diversified Index and should provide a degree of protection in the event that markets suffer another leg higher in yields.
Historically high yields
Despite the short duration of this EM strategy, it packs a punch when it comes to yield with a yield to worst of 5.68%. Aside from the squeeze higher in yields at the onset of the COVID crisis, this is the highest yield in more than 10 years (see chart below). Spreads to US Treasuries have also widened out to 310bp. Over the last 10 years, visits into the 300bp-plus area have been rare and, aside from during COVID, short lived.
Diversity of issuers
The ICE BofA 0-5 Year EM USD Government Bond ex-144a Index has 58 country issuers. A deteriorating global growth outlook is not a constructive backdrop for EM debt but the worst-rated issuers are excluded. Within the ICE BofA 0-5 Year EM USD Government Bond ex-144a Index, just 3.4% of bonds are rated below single B, against 6.5% for the JP Morgan EMBI Global Diversified Index.
This spread of issuers can assist in portfolio diversification: the ICE BofA 0-5 Year EM USD Government Bond ex-144a Index has had a correlation of just 12% to US Treasuries based off monthly data over the past 10 years despite being a USD-denominated asset. It is also worth noting that many nations that issue USD-denominated debt are commodity producers that receive a large proportion of their foreign earnings in US dollars.
Yield to Worst and Spread to Treasuries at Elevated Levels for ICE BofA 0-5 Year EM USD Government Bond ex-144a Index