Emerging-market government debt is off to its worst start since 1995 as rising U.S. Treasury yields dim the allure of the securities and investors shift to corporate bonds in developing countries.
JPMorgan Chase & Co.’s EMBI Global Index has lost 2.3 percent this quarter as average emerging-market bond yields rose to 4.96 percent on March 27, the highest level since August, from 4.50 percent on Dec. 31.
“The 5 percent yield is not attractive if you are fearful that one of the biggest negatives going forward is the rising of Treasury yields,” Jeremy Brewin, who oversees more than $5 billion of fixed-income assets as the head of emerging-market debt at Aviva Investors, said in a March 21 telephone interview from London. “There’s no compelling reason to dash in.”
Aviva Investors, which has beaten 81 percent of peers over the past three years, is reducing holdings of long-term emerging-market bonds, which are the most sensitive to U.S. Treasury moves. Paul Denoon, who oversees $27 billion as head of emerging-market debt at AllianceBernstein Holding LP, said he is allocating 15 percent of assets to emerging-market corporate bonds, approaching the upper limit of his mandate.
Brewin said he isn’t “really keen to pile on” long-term bonds until yields on the benchmark JPMorgan index move to 6 percent. Aviva’s $1.65 billion Emerging Markets Bond Fund returned 9.9 percent annually over the past three years, according to data compiled by Bloomberg.
U.S. 10-year Treasury yields reached an 11-month high of 2.08 percent on March 8 as a recovery in the U.S. housing market fueled speculation that the Federal Reserve will end its bond purchases and withdraw monetary stimulus. The yields have since fallen 23 basis points to 1.85 percent as banking turmoil in Cyprus rekindled the European debt crisis and spurred demand for Treasuries as a haven.
Ten-year Treasury yields will rise to 2.31 percent by the end of the year, according to the median forecast of analysts surveyed by Bloomberg.
Enzo Puntillo, the head of fixed income and a portfolio manager for emerging-market securities at Swiss & Global Asset Management AG in Zurich, said he’s starting to add emerging-market bonds, expecting a return as high as 7 percent over the next 12 months.
U.S. Treasuries are stabilizing as the Fed reiterates commitments to keeping borrowing costs low, according to Puntillo. At about 5 percent, emerging-market bond yields are high enough to withstand volatility, he said.
“It is one of the most attractive credit asset classes right now,” Puntillo said. “Five percent yield is not that bad overall, considering that you get zero yields in most safe assets and you need to go in pure high-yield corporates to get 5.5 percent yield or so.”
Emerging market corporate debt returned 1 percent this year, JPMorgan’s CEMBI Broad Diversified Index shows. Average yields have increased to 4.62 percent, from 4.55 percent on Dec. 31.
AllianceBernstein’s Denoon said he favors corporate securities over emerging-market government bonds.
“We are broadening into corporate bonds to get the benefits of diversification,” Denoon said.
Emerging-market corporate bonds are less sensitive to Treasury moves than the government bonds, according to data compiled by Bank of America Corp. The average duration of emerging-market government debt, a measure of sensitivity to interest-rate moves, was 7.05 years, compared with 5.23 years for corporate securities, Bank of America’s data show.
A JPMorgan survey last month showed investors reduced holdings of emerging-market government debt to the lowest level since October 2008. JPMorgan cut its recommendation on emerging-market dollar-denominated government bonds to neutral from overweight on March 7.