India Brings Yield and Low Correlation to EM Debt

“Once
completed,
India
is
expected
to
have
a
10%
weighting
in
the
JPM
GBI-EM
Global
Diversified
benchmark
index.
Other
benchmarks
will
also
change
and
India’s
weight
will
vary.
In
any
case,
India
will
become
one
of
the
largest
exposures
in
emerging
bond
indices,
along
with
other
major
issuers
such
as
China,
Indonesia
or
Mexico,”
says
Jose
Garcia-Zarate,
head
of
passive
strategies
research
at
Morningstar.

The
rollout
will
take
place
gradually
over
10
months,
at
an
inclusion
rate
of
around
1%
per
month,
he
adds.

Go
Active
or
Passive
on
EM
Debt?

Investors
have
a
range
of
ways
into
EM
debt,
but
they
are
not
equal
in
terms
of
risk.

“On
paper,
the
complexity
of
the
emerging
bond
universe
would
justify
an
active
approach,
as
managers
may
be
able
to
pick
the
right
bets
in
terms
of
country
and
currency
exposure,”
Garcia-Zarate
comments.

“However,
active
bets
on
emerging
market
debt
remain
fraught
with
risk,
whereas
a
low-cost,
broad-based
passive
approach
balances
them
out
in
the
long
run.
This
has
resulted
in
a
more
stable
risk/return
profile
for
index
funds
than
the
average
of
competitors
in
the
Morningstar
category,
and
this
is
likely
to
remain
the
case
going
forward.”

To
date,
there
are
six
local
currency
emerging
market
bond
exchange-traded
funds
among
those
domiciled
in
Europe.

Well-diversified
passive
funds
have
performed
well
in
the
context
of
their
Morningstar
category,
which
also
includes
active
products.
In
particular,
passive
strategies
that
track
to
indices
with
a
quality
bias
proved
better
at
cushioning
the
downside
and
provided
higher
returns
over
the
long
term.

India
Brings
Performance
and
Diversification

In
an
interview
with
Morningstar,
Pradeep
Kumar,
emerging
markets
debt
manager
at
PGIM
Fixed
Income,
said:
“In
its
current
form,
the
GBI-EM
index
needs
more
countries
with
higher
yields
and
a
low
correlation
with
the
US
Treasury
market.
After
the
exclusion
of
Russia
in
2022
and
the
collapse
of
Chinese
bond
yields,
the
index’s
overall
spread
against
US
yields
has
narrowed
significantly.”

The
combined
weight
of
China,
Malaysia
and
Thailand
is
30%
and
the
bond
yields
of
these
countries
are
below
4%.

“With
a
7%
return
in
the
India
sub-index,
its
inclusion
will
not
only
increase
the
overall
index
return
but
also
add
diversification.
The
Indian
bond
market
has
a
much
lower
correlation
than
the
core
bond
markets
and
local
idiosyncratic
factors
are
much
more
crucial
than
global
ones,”
Kumar
added.

According
to
Pramol
Dhawan,
head
of
emerging
market
portfolios
at
PIMCO,
in
an
interview
with
Morningstar:
“The
introduction
of
India
will
increase
the
index’s
return
by
6
basis
points,
while
reducing
its
volatility.”

The
manager
points
out
that
the
index
will
become
more
diversified
and
will
be
better
able
to
provide
a
smoother
stream
of
returns
as
more
countries
become
eligible
for
inclusion.

“The
index
weightings
will
gradually
increase
by
1%
per
month,
leading
to
an
inflow
of
around
$35
billion
into
the
Indian
local
currency
bond
market.
This
change
is
expected
to
have
a
minimal
impact
on
spreads,
as
it
has
been
well
communicated,
but
more
importantly
it
will
greatly
improve
liquidity
conditions,”
Dhawan
explained.

Emerging
Markets
are
Still
Risky

It
should
be
noted
that
investors
wishing
to
access
the
Indian
government
bond
market
have
been
able
to
do
so
for
some
years
now
through
various
ETFs
that
track
a
100%
Indian
bond
index.
For
example,
the

L&G
India
INR
Government
Bond
ETF,
launched
in
2021,
has
gathered
a
fair
amount
of
assets.

“However,
for
most
investors,
allocation
to
emerging
markets
is
rarely
done
through
bets
on
a
single
country
and
they
prefer
to
opt
for
broadly
diversified
country
strategies,” continues
Jose
Garcia-Zarate.

This
is
because
emerging
markets
have
multiple
risk
factors,
in
particular
monetary
policy
movements
and
politics.
For
this
reason,
a
diversified
approach
helps
hedge
the
risk
of
too
much
exposure
to
a
single
country,
which
is
why
India’s
inclusion
in
the
overall
benchmarks
is
particularly
appreciated
by
the
market.

“With
India’s
entry,
investors
in
broad-based
emerging
bond
funds
should
expect
an
increase
in
Asian
exposure
at
the
expense
of
other
geographies,”
Garcia-Zarate
says.

“It
is
expected
that
the
European
emerging
market
group
will
be
the
one
that
will
suffer
the
biggest
drop
in
weight.
This
means
that
current
investors
in
these
funds
should
prepare
for
a
change
in
their
exposure,
although
they
will
continue
to
benefit
from
a
wide
diversification
at
the
country
level.”

Opportunities
in
Emerging
Local
Currency
Debt

After
a
long
period
of
underperformance,
emerging
local
currency
debt
is
back
in
the
spotlight.
This
trend
is
also
due
to
the
fact
that
the
US
dollar,
which
has
risen
relentlessly
for
the
past
15
years,
may
have
started
to
come
to
a
halt.

As
can
be
seen
in
the
chart
above
compared
to
a
basket
of
emerging
currencies,
the
dollar
appreciated
by
almost
50%
on
a
trade-weighted
basis
between
June
2008
and
October
2022.
The
result
was
a
US
dollar
overvalued
by
more
than
10%
and
emerging
market
currencies
undervalued
by
more
than
20%.
This
has
been
tough
for
emerging
economies,
which
have
suffered
from
dollar
strength
in
several
forms:
lower
investment,
higher
debt
costs,
and
strong
inflationary
pressures.

The
dollar’s
strength
has
been
more
or
less
universal:
it
has
risen
against
almost
all
currencies,
in
both
emerging
and
developed
markets.
Now
with
the
expected
change
in
monetary
policy
by
the
Federal
Reserve,
the
possible
reversal
–
or
even
just
a
sideways
movement
–
of
the
dollar
should
support
emerging
market
assets.

“We
are
cautiously
optimistic
on
local
bonds.
Our
base
case
scenario
is
for
the
Fed
to
cut
rates
once
or
twice
in
2024
and
extend
the
easing
cycle
in
2025,”
Pradeep
Kumar
said.

“We
believe
that
significant
value
has
been
created
in
light
of
current
starting
yields
and
that
emerging
market
investments
will
bring
significant
variety
and
yield
enhancement
to
global
fixed
income
portfolios,”
ramol
Dhawan
added.

Indeed,
during
2023,
expectations
of
a
less
aggressive
Fed
helped
attract
new
investments
to
emerging
market
bond
markets,
after
investors
had
abandoned
the
asset
class
following
recurring
rate
hikes
in
the
previous
year.

US
Inflation
and
the
2024
Election

When
taking
exposure
to
emerging
markets
there
are
several
factors
that
should
be
taken
into
account.
Compared
to
their
developed
counterparts,
emerging
market
bonds
are
riskier,
typically
more
illiquid
and
have
higher
transaction
costs.
In
short,
despite
the
more
promising
outlook,
those
investing
in
emerging
market
bonds
should
be
aware
of
the
risks.

“The
main
risks
stem
from
a
pick-up
in
US
inflation,
which
would
lead
to
a
sell-off
in
US
rates,
and
the
failure
to
consolidate
fiscal
deficits
in
Brazil
and
Mexico.
The
outcome
of
the
US
presidential
election
and
the
post-election
US
fiscal
outlook
could
also
put
pressure
on
rates
and
local
currencies,”
PGIM’s
Kumar
said.

Moreover,
while
offering
more
attractive
yields,
emerging
market
bonds
now
face
increased
competition
from
developed
market
government
bonds,
that
are
significantly
less
risky
and
offer
real
yields.

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