Professional investors are piling into emerging market bonds – should you be too?

As ever, a high-yielding asset is typically one that the market doesn’t trust.

Emerging market debt has become increasingly popular among bond investors over the past two years, according Invesco’s latest Global Fixed Income study.

In its third annual survey of chief investment officers and bond investors from around the world, Invesco found that 72% of investors had an allocation to emerging market debt. In comparison, just 49% did so in 2018.

Perhaps unsurprisingly, emerging market bonds have proved most popular among investors in the Asia-Pacific region, with 89% saying they had an allocation.

While specific data for the UK is not available, that figure was 80% for investors in the EMEA region (Europe, Middle East and Africa). North American investors were least likely to have an allocation, with just 51% doing so.

Historically, many investors have had emerging market bond exposure primarily for diversification reasons. However, increasingly they appear to be opting for the asset class in a bid to boost returns, given the backdrop of historically low yields in developed economies.

• The fund managers betting on healthcare and work-from-home themes

As Nick Tolchard, head of EMEA at Invesco Fixed Income, notes: “With low yields on offer in their core portfolios, EMEA investors have piled into emerging market debt to boost returns. 69% of those invested in it have done so for returns.”

While those surveyed are professional investors, private investors have found themselves in a similar situation in recent years.

Yields on bonds in developed economies have collapsed, resulting in many now providing a negative real return. Meanwhile, low bond yields have pushed investors towards seemingly reliable income-paying stocks (often called bond proxies), thereby bidding up their prices and reducing their yields.

Emerging market debt, then, is seen by some investors as one of the few corners of the market still providing a decent income. Several of the highest-yielding funds across all asset classes being focused on emerging market debt.  

However, private investors should tread carefully. As Adrian Lowcock, head of personal investing at Willis Owen, notes: “It has long been seen as the riskiest area of the bond market. The political situation in many emerging market countries can be unstable, which can introduce risk and volatility.”

• Three ideas for income in the dividend drought

Investors should remember that many emerging market governments have a poor record on investor protection, particularly when it comes to foreign investors. In addition, corporate issuers in emerging markets are more likely to default than their developed market counterparts.

On top of that, emerging market bonds are acutely sensitive to changes in the economic outlook, and evidence of an economic slowdown often sends investors rushing for the exit, as has happened recently with Covid-19 fears.

With the crisis causing the value of the dollar to surge and extra pressure on the finances of emerging market governments and businesses, the risk of default for many bonds has grown even larger.

As ever, a high-yielding asset is typically one that the market doesn’t trust.