Emerging market local currency bonds offer investors a broad range of income and diversification opportunities. According to Peter Becker, Fixed Income Investment Director at Capital Group, a substantial portion of the investable market remains overlooked by common indices. In recent years, the segment has experienced significantly increased issuance activity and improved liquidity. At the same time, the actual investment universe far exceeds traditional benchmarks.
An index serves primarily as a guide but does not provide a complete reflection of market opportunities, Becker explains. For active investors, it is worthwhile to consider smaller issues, shorter maturities, and securities outside traditional sovereign bond indices. Furthermore, rigid index weightings carry structural disadvantages. With yields in many Asian markets currently comparatively low, this dampens passive investment vehicles. In contrast, selected Latin American markets offer noticeably higher real yields, backed by appropriate fundamental strength.
Diverging interest rate cycles and targeted risk management
Increasing divergence among individual economies calls for nuanced macroeconomic scrutiny. Becker highlights that inflation, economic growth, public finances, and central bank policies are developing unevenly. While some emerging markets are already cautiously lowering their key interest rates, other central banks remain in a wait-and-see stance in the face of elevated energy prices or are tightening their monetary policy once again. Even where two sovereigns present comparable yields, their monetary policy outlooks can differ considerably and have a decisive impact on price performance.
Alongside interest income, the total return of local currency bonds is determined by multiple factors that can develop independently of one another. Becker emphasises that an attractive bond does not automatically represent a favourable currency investment. An active approach allows interest rate and currency risks to be evaluated separately and hedged in a targeted manner. Key return drivers include:
- —Duration as well as positioning along the yield curve
- —Currency movements and their hedging options
- —Country-specific liquidity across the respective bond markets
Exploiting technical market mechanisms and risk discipline
Regular index rebalancings create additional scope for action. While passive strategies are obliged to track reallocations, active managers can build positions in advance or capitalise on temporary price distortions. Such price movements often reflect pure index mechanics rather than shifted fundamentals, demanding a sound understanding of market mechanics.
Strict risk discipline remains crucial for long-term performance. In Becker's view, successful active management does not mean taking on as many risks as possible, but rather consciously avoiding or rigorously hedging incalculable factors.
