Emerging market bonds: Brazil returns 7.5% in real terms
Despite of the low interest rate environment, there may be attractive opportunities in emerging market bonds. In this interview, portfolio manager Enzo Puntillo explains how to take advantage of them.
We believe that emerging market bonds currently offer a wide range of opportunities. This is not only because of the stronger growth momentum relative to developed markets, which we believe will continue. The asset class could also be supported by inflation and interest rate developments.
Inflation in emerging markets has been better than in the US or the EU. One of the main reasons for this is that fiscal and monetary stimulus has been significantly lower in emerging markets. In addition, emerging market central banks started their cycle of interest rate hikes much earlier. Accordingly, they have already entered the cycle of rate cuts.
Hard or local currencies?
The low interest rate environment is now a reality, especially in Switzerland. By contrast, emerging market debt offers an attractive yield to maturity of 7.5%. Despite a strong US dollar and rising interest rates in the last quarter of 2024, the JPM EM Bl end Sovereign-only 50-50 (JEMBAGTU), a blend of 50% hard currency and 50% local currency bonds, posted a positive performance of 2.01% in USD last year. The asset class has thus demonstrated its return potential and should now benefit from the developments we expect in 2025.
Active Selection
The 'Swisscanto (LU) Bond Fund Responsible Emerging Markets Opportunities' invests flexibly and actively selects from the entire universe of emerging market bonds. Investments are made in both hard currency and local currency bonds, depending on the attractiveness of the yield opportunities. The decision between hard currency and local currency bonds is made at the country level, which can significantly enhance return potential. Launched in 2020, the fund had CHF 437 million in assets under management as of 31 December 2024. After adding local currency bonds and reducing Mexican bonds last quarter, we confirmed our active positioning this quarter.
However, expertise is still required to capture the return opportunities and avoid the risks in this market. For example, many investors may find it difficult to decide whether to invest in emerging market bonds via hard currencies or local currencies. Our approach covers both markets and we measure ourselves against the blend index described above (50% HW/50% LW). We analyse each country individually and decide whether to invest in hard currency or local currency. This is in contrast to the approach taken by many investors, who only decide between hard and local currency (see 'Asset class approach' below). We believe this approach offers many more opportunities to generate alpha in portfolios.
We see particular opportunities in local markets where real yields are very attractive. In Brazil, for example, real bond yields are 7.5% after inflation. And in South Africa or Indonesia, real bond yields are above 5%. We also see opportunities in hard currency bonds in some niche frontier markets. Turkey is new to our radar screen. We have avoided Turkish bonds for the past four to five years, but now see good opportunities for re-entry.
Keeping an eye on the Triple T
One of the biggest risks this year is the so-called 'Triple T': 'Trade, Tariffs and Trump', i.e. potential trade conflicts, higher tariffs and the inauguration of new US President Donald Trump. This is likely to cause volatility in the markets and could certainly affect bond investors' return expectations.
Nevertheless, we expect some bonds in some of our preferred countries, such as Brazil, to perform well. In addition, valuations in various segments of emerging markets look much more attractive than in developed markets. Spreads are attractive and real interest rates are at their highest levels in decades, both in absolute and relative terms. Finally, we believe that emerging market currencies are relatively cheap.
Learn more about emerging market bonds at our Investment Meeting on 16 January (Zurich), 23 January (Lausanne/Geneva) and 28 January (Berne/Basel).
