Investors including JPMorgan Asset Management, M&G Investments and Aviva Investors said they seized on the retreat in riskier assets at the start of the month to bolster their holdings of emerging-market bonds.

While a small chorus of fund managers warned of a new retreat if fresh US recession fears emerge, others are betting on a period of steady easing by the US Federal Reserve (Fed) that burnishes the appeal of higher-yielding assets in developing nations. The more risk-tolerant recommend locking in high yields in markets like Ukraine and Ecuador.

“Emerging-market bonds can deliver - reasonably easily - a double-digit return this year,” said Pierre-Yves Bareau, the London-based global head of emerging-market debt at the JPMorgan unit, who oversees US$52 billion in emerging-market debt. “Four-hundred basis points is an attractive spread for investors, but it’s not a crisis spread.” 

The bounce-back has been swift across asset classes. If the current pace of gains for emerging-market dollar sovereign and corporate bonds is maintained for the full year, they would deliver a return of more than 8%, a Bloomberg index showed. That’s almost double the rate for equivalent US bonds.

As concern about weak US data and a rate hike in Japan drove the rout at the start of August, the extra yield investors demand to hold sovereign emerging debt rather than US government paper climbed for nine days straight, the longest run in about six years, according to a JPMorgan Chase index. About US$400 million left global emerging-market bond funds in the week ended Aug 7.

“I wouldn’t overinterpret the recent price action,” said Philip Fielding, a co-head of emerging markets at Mackay Shields in London. “Emerging markets have coped with this higher interest rate environment.”

Liam Spillane, the head of emerging-market debt at Aviva Investors Global Services, said the retreat “provides us with some opportunities in some of those high yielding, more idiosyncratic names”, such as Ecuador or Ukraine. Claudia Calich at M&G Investments used the spread widening to add bonds of Peru. 

Others recommended sitting tight and letting the comparatively higher yields do their thing. 

The average yield on sovereign dollar bonds from emerging markets was at 7.4% last Friday, about one percentage point above the five-year average, and almost double the rate in January 2021, a Bloomberg index showed.

Not everyone agrees the weakness is temporary. Should the Fed cuts rates in response to weaker economic data rather than slowing inflation, a new bout of risk aversion would be triggered, they said.

Vikram Rahul Aggarwal, the lead fund manager of Jupiter Asset Management, said his holdings of hard-currency emerging-market bonds were the lowest they had been in several years. 

He cited the challenging geopolitical outlook, while a “pronounced deterioration in global economic data” would punish developing-nation foreign currency bonds.

“It is important to draw a distinction as to why the Fed is cutting rates,” said Jennifer Taylor, the head of emerging-market debt and senior portfolio manager in the global fixed income beta solutions group at State Street Global Advisors. “If it is because the US has entered a recession, then this would be bad for most risk assets - emerging-market debt included.” 

Wall Street is betting that Fed chair Jerome Powell will confirm that interest-rate cuts are coming at the central bank’s annual confab in Jackson Hole, Wyoming this week.

Meanwhile, JPMorgan’s Bareau is getting “more engaged” in Asia. He said his base-case scenario is that the US avoids a recession as the economy slows and the Fed cuts, allowing investors to benefit from historically high emerging-market yields.

Developing nations offer a way for investors who have become over-reliant on the US to diversify their portfolios and capture returns, he said.

“More investors will be looking at emerging markets.” 

  - Bloomberg