There's still opportunity in the segment, though the pandemic has caused significant and nuanced divides
As the COVID-19 impact left a ubiquitously negative impact across the world, many investors turned optimistic on the prospects for emerging markets, which they said did not have the capacity to whether the pandemic as well as advanced economies.
But a recent commentary by Nicholas Hardingham, senior vice president and portfolio manager in Franklin Templeton’s Fixed Income group, argues that there are still compelling reasons to continue backing emerging markets next year.
Citing the International Monetary Fund, Hardingham said advanced economies are expected to see their budget deficits worsen by 11% of GDP because of the COVID crisis, compared to just 6% of GDP in emerging markets. Going into 2021, government debt is forecast to balloon to 125% of GDP in advanced economies, in contrast to 62% for emerging markets.
“In addition, EM government bonds are attractive to us, compared to other bonds, because they yield around 4% more per year than government bonds in advanced economies,” he said.
GDP growth, meanwhile, is expected to clock in at 3.9% on average among advanced economies in 2021, less than the 6% expected for emerging markets.
While emerging markets entered 2020 in good shape, Hardingham said the COVID crisis has put them on divergent economic paths. One group, including countries such as Chile and Poland, are able to finance widening deficits while keeping debt levels sustainable, continuing to issue bonds at low interest rates, thanks to significant buffers they have in place.
Another group, including South Africa and Brazil, came into 2020 with high debt levels and large chunks of their budgets going to interest payments. Their debt levels are limiting their spending, but they are able to lean on their deep domestic capital markets and have little foreign currency-denominated debt to speak of.
The least fortunate group includes countries like Suriname and Sri Lanka, Hardingham said. They came into 2020 owing large debt repayments and mostly weak economies, which were compounded by the COVID shock. While some of these countries have gotten temporary relief from governments to which they owe money, their governments have been effectively prohibited from raising private capital.
“In addition to EM governments, many companies in these countries issue attractive bonds, in our view,” Hardingham said. Such corporate issuers typically pay higher interest rates with better credit ratings on average than their counterparts in advanced economies, he said, adding that many are either government-backed or large and well-diversified.
And aside from having had fewer default rates than developed-market corporates in recent years, EM corporate bonds have outperformed EM government bonds year-to-date.
“EM bonds will offer a wider range of risk/return combinations in 2021 than in previous years, in our view,” Hardingham said. “We believe that understanding this universe in depth will be key to putting together successful portfolios for our investors.”