Volatility creates buying opportunities in emerging markets fixed income

“We all know that EM spreads will become more volatile when interest rates turn, but rewards will be available for smart investors who understand that not every spike is a precursor to a decline in the underlying credit quality of the companies or countries that have issued the bonds,” Mr. Saichin said.

Markets have over-estimated volatility as a sign of solvency risk in the past, notably in the troughs of 2008 and 2011. In those years, EM corporate bonds rated BBB- sold off substantially, implying an inflated level of defaults that never materialised.

The implied default rate for 2008 was 47.4% compared to cumulative realized defaults of just 5.89% in the next five years. In 2011, implied defaults were 30% compared to a five-year realized rate of 6.21%. [1]

Emerging market debt has been an important contributor to enhanced returns and portfolio diversification in the years of loose monetary policy and exceptionally low yields on sovereign debt in the developed nations. Investors have flocked into the asset class, swelling primary issuance, but concerns are now mounting about the scale of the potential sell-off and rotation into Treasuries as US interest rates increase.

“We are an active, specialist manager and this is the environment where our trained eye and experience comes into its own,” continued Mr. Saichin. “If you believe that the solvency of a target investment is robust, short-lived volatility is a positive factor that opens up buying opportunities. We find those by analysing top-down individual country risk and bottom-up corporate business models, capital structures and bond contracts.”

Ahead of interest rate normalization, Allianz Global Investors prefers corporate bonds with a duration of three years or less, assuming those credits raise no major solvency concerns.

The asset manager also favours sovereign bonds with a duration of seven years or less.