Emerging economies are outperforming developed economies
Erste AM expects to see solid growth rates in the emerging markets also in the future. According to the International Monetary Fund, GDP per capita should increase by 32% in the coming five years. At 64%, this growth rate has been significantly above that recorded by the developed economies (24%) in the past ten years (source: IMF). The emerging economies in Asia excel as growth engine: GDP per capita has more than doubled over the same period of time in Asia (+111%). Emerging and developed economies have thus continued to converge. For example, GDP per capita (in USD, adjusted for purchase power) in the emerging economies amounts to USD 11,800, that in the developed economies to USD 49,000.
Positive for the capital markets: falling inflation
Year / inflation rate (emerging markets globally)
1997: 12.8 %
2007: 6.5 %
2017: 4.9 %
Almost as remarkable as the strong real growth is the decrease in inflation we have seen. “This is due to the successful monetary policy of the central banks, among other reasons”, as Erste AM chief economist Gerhard Winzer explains. Overall, the low inflation makes forecast models more precise. Also, it represents a good indicator for improved resource allocation.
China: soft landing expected
China plays a crucial role for the development of the emerging markets. However, growth rates of 20% y/y were not sustainable. The current trend is towards a gradual slowdown of economic growth. It comes with a structural transition of the economy, as exemplified by the internationalisation of the renminbi. The economic cycles remain dominated by a classic stop-and-go policy: a period of economic stimulus is followed by a period of restrictive measures.
Resilience due to flexible currencies
The flexible currencies have a positive impact on the economic development of emerging markets. In case of crises, they can depreciate, which takes care of a significant part of domestic adjustment that is needed in such a situation (e.g. Greece). This is also beneficial for the default risk of the respective country. The falling commodity prices in the first half of this decade have played an important part in the depreciation of the Russian rouble and the Brazil real. This has helped overcome the respective recessions. India, too, has been faced with imbalances at the beginning of this decade. The current account deficit was elevated, among others. The weakening of the rupee helped cut the deficit and step up economic growth.
Decreased interest rates in the USA and the rest of the developed world
Not only have the actual nominal interest rates fallen, but the natural interest rate is also clearly below previous levels. The natural interest rate is the rate which neither stimulates nor dampens economic growth or inflation. For the status quo, this concept can be resorted to for an assessment of how much interest rates can rise. In the USA, the real, natural interest rate is currently 0% (according to a working paper by the Federal Reserve Bank of San Francisco). The nominal, natural interest rate at 2% inflation is therefore only 2%. Given the current key-lending rate of 1%-1.3%, the potential for rate hikes is limited.
Corporate bonds benefit from ongoing deleveraging and higher spreads than for comparable companies from the developed economies
In its asset allocation, Erste AM currently prefers emerging markets corporate bonds. The ongoing deleveraging and the low leverage to start with are among the strengths of this asset class. This translates positively into the rating of the respective countries and thus the individual companies.
Emerging markets corporate bonds: issue volume quintupled
Péter Varga, Senior Professional Fund Manager Emerging Market Corporates with Erste AM: “Since we launched this asset class, the investment universe of emerging markets corporate bonds has matured noticeably. While we were one of the first asset managers to engage with this asset class back then, the market volume has quintupled in the past years. At a volume of USD 1.7 trillion, the market for emerging markets corporate bonds is now almost as big as that for US high-yield bonds.”
Emerging markets corporate bonds are an attractive asset class particularly for investors with a long-term investment horizon and the willingness to assume a certain degree of risk. Companies in the emerging markets are by far less leveraged than companies in the developed economies. The average credit rating is BBB- to BB+, i.e. at the threshold to the high-yield segment, while the combined debt load of all emerging markets companies combined amounts to only half of that carried by the US high-yield issuers, as Varga points out.
Long-term yield of 5-6% realistic for emerging markets corporate bonds
Taking into account demographic shifts, Erste AM fund manager Péter Varga expects retail investors to step up their allocation to emerging markets corporate bonds: “People want to reduce their shareholdings and instead generate ongoing return from interest income as they are getting older.” Emerging markets corporate bonds with a long-term yield of 5-6% would lend themselves to this purpose. And even in times of rising yields, the spreads are still high enough to absorb negative effects.
Since the launch of ERSTE BOND EMERGING MARKETS CORPORATE (AT0000A05HQ5; distributing fund) in 2007, Varga and his team have achieved a compound annual growth rate of 6.4%. This track record has earned them multiple awards, among them a Morningstar rating of five out of five stars. Assets under management amount to EUR 426mn (as of 30 June 2017). The fund management team in charge manages close to EUR 1.7bn worth of mutual funds invested in emerging markets corporate bonds and institutional mandates.
*) The ratio “yield” equals the average yield of the securities held in a fund, portfolio, or index prior to fees resulting from foreign exchange hedging transactions; please bear in mind that the ratio “yield” is not tantamount to performance. For a performance overview of the funds mentioned, please visit our website. The aforementioned yield does also not include costs reducing the rate of return such as management fees or individual account or depositary fees.
Please note that forecasts are no reliable indicator for future developments.
For legal documents and further information on the aforementioned funds, please visit www.erste-am.at.
ERSTE BOND EMERGING MARKETS CORPORATE EUR R01