In quest for alternatives to China, West prefers to bet on EM bonds

A recent report by Pictet Asset Management has pointed out that emerging Mmarket bonds are a lucrative investment for global investors since China has emerged as a counterweight to the Western world, specifically the U.S. As a result, the West prefers to bet on other emerging markets in its quest for alternatives to China. The geopolitical change—primarily being driven by Europe and the US—in a post-USSR era is proving advantageous to Emerging Markets.

Low foreign ownership of emerging market debts, particularly local currency debts, offer investors good risk and reward opportunities, especially because most of these currencies are significantly undervalued, states the report.

The emerging markets fixed income not only exhibits low correlation to core fixed income asset classes, U.S. treasury bonds and investment grade credit, but is also not co-related to U.S. equities. At the same time, sub-asset classes within emerging market bonds, hard currency sovereign, hard currency credit, local currency sovereign, local currency credit, are also relatively uncorrelated with each other. This creates opportunities for diversification within an emerging market fixed-income allocation.

As per the research, investments are also flowing into emerging markets because the alternative-to-China phenomenon has expanded the middle class of the emerging markets who have deeper pockets now and are investing monies in their markets. For instance, India, due to its humongous population, has attracted giants like Google by providing the twin benefits of well-skilled human resources and a large consumer base, at the same time.

India’s inclusion in JPMorgan Bond Index

In a major development for the bond market, the Indian government bonds were included in the JPMorgan Government Bond Index (Emerging Markets) in June this year. This inclusion paved the way for substantial inflows of foreign capital into the Indian economy.

According to JPMorgan, the average maturity of Indian bonds included is 7 years, with a Yield-to-Maturity of 7.09%. India becomes the 25th market to be included in the Index since its launch in June 2005. This inclusion is anticipated to result in global flows worth $20-25 billion into the Indian bond market.

India’s inclusion in the JPMorgan Government Bond Index is anticipated to increase Asia’s weight in the Index to 47.6%, according to a note from HSBC. This inclusion will result in Europe, Middle East, and Africa region (EMEA region) weight cutting down to 26.2% by March 2025 from current 32%.

Investing in Emerging Market Bonds

Making a case for the prudence of investing in the Emerging Market Bonds, the Pictet report states that today’s emerging market economies are much more mature and well-ordered as compared to those of the past. The debt-to-GDP ratios in developed markets have jumped from 70% in 2000 to 126% at present, while the debt-to-GDP ratios of emerging markets, including China, have risen from 47% in 2000 to 68% at present, and 52-57%, for ex-China emerging markets.

The report also points out that the alternative-to-China phenomenon has also focused the attention of the governments of these nations to invest in infrastructure development and development banks are competing to invest in the Emerging Markets, like the IMF in Latin America, World Bank and US Treasury in West Africa etc. Collectively, these banking institutions are providing an important backstop to sovereign credit markets and reducing the risk of default, while funding investments.

Pictet report notes that in the long run multiple trends will play out in emerging market investments. In some phases investors taking greater exposure in sovereign and corporate credits will get rewarded while other phases will favour extending duration. In other phases, investing in local currency bonds and currencies of emerging markets will yield windfalls. However, crucial to the success of the investment strategy will be ability to dynamically allocate across the whole range of emerging market assets, says the report.

The report also highlights the rising trend of re-shoring and near-shoring aimed at reducing dependence on China. For instance, the markets of Latin America have benefitted from the near-shoring policies of the USA in the latter’s bid to reduce dependence on China. On the other hand, Chinese companies, realising the threat to their dominance, have voluntarily shifted a part of manufacturing to the South-East-Asian countries. So, the Chinese goods would continue to reign over the world while benefiting other emerging economies by creating more jobs and partnering in development of better infrastructure in other Emerging Markets.