- Continued policy support and economic recovery projections support overall outlook for EMD
- Asian debt markets will likely continue their strong rebound as vaccine rollout reinforces further normalisation
- ESG will play a bigger role in emerging market debt investment
Expectations for emerging market debt (EMD) were relatively positive at the onset of 2020. The Covid-19 pandemic sent these expectations into a tailspin. As the world’s recovery from the COVID-19 pandemic gathers pace this year, where might the best opportunities lie in EMD?
For 2021, the main themes for the EMD asset class will be the recovery in fundamentals and supportive technical conditions as investors searching for yield re-risk rather than de-risk their investment portfolios. Asian – and especially Chinese – bonds offer some of the strongest growth opportunities in EMD.
Asia is well ahead in the recovery phase and NN IP expects its debt markets should continue their strong rebound in 2021 as the vaccine roll-out supports further normalization. Credit metrics are likely to improve gradually and a continued economic recovery should allow spreads in the region to tighten in 2021, although the challenges of Covid-19 containment and continued US-China tensions present key risks. Although the new Biden administration is expected to adopt a less hostile and more predictable foreign policy approach, the tensions surrounding trade and technology issues are unlikely to abate. NN IP sees good value in the Chinese property and the Thai banking sectors at current spread levels, while Indian debt faces the risk of a sovereign downgrade.
NN IP expects mid- to high-single-digit total returns for 2021 in EMD, owing to attractive carry, continued spread compression, the ongoing search for yield in the low-rate environment and the limited impact of rising US Treasury yields. Frontier market returns should bounce back in 2021 despite vaccine sourcing and distribution challenges while local currency bonds could benefit from currency appreciation enhancing returns, although volatility remains. In hard currency bonds, NN IP expects high yield to recover lost ground and for regional divergence to continue.
“The combination of economic recovery and continued dovish monetary stance signaled by DM authorities will support the EMD asset class. Divergence in the EM-DM growth differential bodes well for capital flows, which stagnated last year.
“East Asian economies, particularly China, were among the world’s most resilient in 2020. Projections for a 2021 recovery, such as the recent growth forecasts from the IMF and World Bank, also favour emerging markets. Based on this macro outlook, we expect positive overall returns for EMD for 2021, which will also be marked by dispersion between regions and countries, creating opportunities for active fundamental investors.”
ESG will also play a bigger role in emerging market investment, NN IP believes. Adamczyk added: “Growing investor demand and strengthening international momentum should be supportive for countries that play a pivotal role in sustainable supply chains. The pandemic has underscored the need for action on social issues and sparked a sharp rise in social bond issuance. We expect issuance of green, social and sustainability bonds to rise apace in 2021 and beyond. EMD strategies that consistently integrate ESG factors and work to tackle still-prevalent data and transparency issues will be best placed to take advantage of this growing segment.”
