Emerging market bonds: These are our favourites

The emerging markets are showing improvements in many respects. For example, they are currently showing more robust economic growth momentum. We are also observing an accelerated disinflation trend. This has developed better in the emerging markets than in the USA or the EU. One of the reasons for this is that the fiscal and monetary stimuli - particularly during the coronavirus pandemic - were much more moderate in the emerging markets than in the US or the EU. In addition, the central banks in the emerging markets began their cycle of interest rate hikes much earlier.

Well-paid risk

We expect local bonds in some of our favourite countries, such as Brazil and Mexico, to continue to perform well. In addition, valuations in various segments of the emerging markets are more compelling than in the developed economies. Spreads are attractive and real interest rates in the emerging markets are at their highest level in decades, both in absolute and relative terms.

Let's take our "favourite countries" Brazil and Mexico, the largest economies in South and Central America: an interest rate of around eleven percent is offset by inflation of 4.5 percent. This results in a real yield of just over six per cent.

Finally, emerging market currencies are also relatively favourably valued. The risk of the lower creditworthiness of emerging markets compared to industrialised countries is therefore offset by exceptionally high returns.

Mix of local and hard currencies

We invest flexibly in our active funds and make a selection from the entire universe of emerging market bonds, i.e. in hard currency or local currency bonds, depending on the attractiveness of the potential returns. The decision between hard and local currency bonds is made at country level. In our view, this investment approach significantly increases the return potential. In the case of USD bonds, we favour countries with limited liquidity problems, a supportive trade balance, robust fundamentals and attractive valuations.

In the case of local currency bonds, we favour countries with attractive valuations and solid or improving trade balance figures. These include Indonesia and the aforementioned Brazil and Mexico. We currently also hold positions in South Africa. We continue to completely avoid local investments in countries with unconvincing real interest rate valuations. There is a risk of an asymmetric risk/return profile here.

Restraint with China

The valuations of Chinese government bonds are not particularly compelling compared to the rest of the emerging market universe. We therefore prefer to remain conservative until we see concrete improvements in the economy. The world's second-largest economy needs to make an adjustment to asset prices in the property sector. The authorities have all the fiscal and monetary policy instruments at their disposal to steer the process and prevent a collapse of the financial sector. However, it will be more difficult to prevent a domestic economic slowdown caused by a decline in investment in the property sector and, above all, a loss of confidence among consumers, whose homes make up a large proportion of their assets.