Because the countries that constitute the emerging market debt universe are so very different from one another, investors should consider an absolute return approach.

Ketan Gada, Senior Investment Manager and Gareth Payne, Head of Alternative Fixed Income Client Portfolio Management, Pictet Asset Management.

Returns in dispersion

As the economic weather turned cloudy during 2021 and storms threatened for 2022, investors became increasingly nervous about holding emerging market (EM) debt. Poor visibility on Covid and the economy made it difficult for some to commit to the market and many walked away: in 2021 net outflows from EM debt funds were the highest since 2015.1 But in divesting wholesale, investors appear to have forgotten some of the reasons they were attracted to EM bonds in the first place.

The fact is the asset class isn’t – and has never been – composed of homogenous investments. The markets that make up the EM bond universe have their own stark idiosyncrasies, which means they don’t react in the same way to the same economic and geopolitical forces – unlike developed markets which more usually move in lock-step. It is this dispersion that gives emerging market debt investors the opportunity to secure excess returns and control risks.

That has certainly the case over the past couple of years. Not only has there been significant dispersion of returns on EM sovereign debt between countries when they, on average, performed strongly in 2020 but also when they suffered in 2021. What’s more, there has been significant variation between regions and on sources of return within countries – whether derived from the coupon payments, or bond performance or currency effects.

An absolute return approach makes it possible to capture those returns even in those periods when the asset class as a whole suffers. So, for instance, Sirius, Pictet’s emerging market’s absolute return debt strategy, managed to generate positive returns net of fees in 2021 when the wider market was down 7 per cent.

And with 2022 throwing up a menu full of significant risks for the emerging universe, ranging from inflation to geopolitical tensions, an absolute approach is once again likely to prove its mettle.