Emerging market debt adds spice to portfolios

“Good-quality” hard-currency corporate bonds issued by emerging market companies are “probably the only alternative to high yield left on the planet, if you want to produce income, with a decent coupon and decent credit risk, but don’t want to have the equity volatility,” says Christian Gattiker, chief strategist and head of research at Bank Julius Baer in Zurich.

The sentiment that emerging market debt could be part of the solution to a search for yield is shared by many other wealth managers.

Since the end of 2013, UBS’ “Yield” portfolio for ultra high net worth investors has included a 5 per cent weighting in emerging market debt – a departure from precisely zero before then. It is, as Mads Pedersen, co-head of asset allocation at UBS Wealth Management in Zurich, notes with a sense of salivation as well as salvation, a “spicy” part of the portfolio – a relatively higher-risk allocation, but one that could help to improve the portfolio’s overall yield. 

Returns can be appetising indeed. Steven Wieting, global chief investment strategist at Citi Private Bank in London, estimates that investment-grade corporate dollar bonds from emerging Asia offer 1 to 2 percentage points more than US bonds of the same rating – with yields of 5.5 per cent achievable for five-year paper. 

All these wealth managers warn, however, of the need to be selective. Julius Baer’s Mr Gattiker prefers to avoid anything low-grade – favouring investment-grade or “slightly below”. Geographically, “we’re very much focused on corporate Asia”, given that “the Bric story has turned into the Ic story: India and China”. As well as Russia’s political and economic problems, Mr Gattiker notes the troubles faced by Latin American countries that have relied on commodities, including Brazil.

Citi’s Mr Wieting is also concentrating on Asia. “The large downward movement of oil has strengthened the case for Asia over other regions,” he notes. The price of crude oil has more than halved since mid-2014. Most Asian countries are major oil consumers, with China the largest net oil importer in the world and India in fourth place. Falling oil prices will make both countries richer, boosting corporate profits. Mr Wieting notes that, aided by this and other factors, China, India and other Asian countries are likely to see future growth rates of 5 to 6.5 per cent – extremely helpful for corporate bonds. 

But despite the search for spice from Mr Pedersen of UBS, he draws the line at local-currency paper, on the grounds that at times when its price is falling, the value of the currency tends to fall too. “When it goes wrong, it goes very wrong,” he says. “It tends to be very nasty, with currencies sometimes losing most of their value.”