Greater Investor Access to Emerging Markets will Fuel their Recovery
It’s impossible to look back at the past 18 months and not compare the stark contrast between the impact and response to the pandemic in developed and emerging markets. The vaccination programs that are well underway in most of the western world, and the billions of dollars being pledged by developed countries for vaccine programmes in developing markets are evidence enough of the two-tier recovery that could emerge.
You see this divergence playing out in bond bid/ask spreads. Our data this summer has shown that in global corporate credit overall, spreads have broadly narrowed to pre-crisis conditions, indicating a return to normality.
But within emerging markets, the recovery picture has been very mixed, with most developing economies behind the curve in their own recoveries. This has translated to impacts on the fixed income market. Our bid/ask spread data showed that for USD denominated emerging market bonds spreads are still 23% wider than pre-pandemic, while in Asia names they are +47% wider for corporates and 88% for sovereign bonds – indicating that the slow recovery, and concerns on short term containment and fiscal outlook, is being priced in.
Foreign investors will play an important part in fuelling the recovery of these important, but fragile, economies. In large part, that will be through the secondary bond markets where emerging market debt changes hands and drives capital funding in these regions. Therefore, ease of access to these secondary markets is obviously important. Electronic trading has become essential in this respect, creating easier connections for investors through which to trade emerging markets. A prime example of this is our recent connection to the Chinese onshore bond market through our partnership with CFETS and Bond Connect, which will give global investors access to this hugely important fixed income market.
But even more important is the broader indexation of emerging markets. Emerging market specialist Ashmore conducted research1 last year that showed only 13% of the nearly $30tn of outstanding emerging market bonds are included in major global bond indices.
Wider inclusion in the main indices would drive much more interest in emerging market debt, with the asset class becoming more standardized and accessible to both the larger institutional asset management firms and pension funds, and also to smaller niche investors keen to specialize and reap the rewards of investing in these markets.
We’ve already seen something of an investor vote of confidence in emerging market debt as they have reaped the rewards of entering new markets despite a challenging yield environment throughout this Spring. Recent data from the Institute of International Finance showed sizeable net inflows for EM bonds for 11 consecutive months, the longest spell like this since 2018 and one that could indicate a return to pre-pandemic levels.2
We’ve also seen more investors trading frontier markets, including Serbia, Vietnam and Nigeria. The tremors in US Treasury yields earlier this year has only pushed investors to look further for a rates-agnostic trade, with frontier markets clearly capable of delivering that.
What this tells me is that if the opportunity is right, and investors understand the market and have the ability to connect to liquidity and transact, then they will move on the opportunity. The effect that this behavioural shift will have on much needed capital flowing into emerging and frontier markets will be significant as these countries and their firms start to recover and rebuild.
On a closing note, central banks around the world are starting to signal the end of pandemic-era monetary stimulus. To consider the impact of tapering on emerging markets, all you need to do is hark back to 2013 and the negative impact of the “Taper Tantrum”. My view is that the situation is luckily different today. With an improving outlook for local-currency EM debt, and on the whole more shock protection built in, the potential for a sustained recovery is possible even when the central bankers tighten up the taps.
What will send these economies on their way will be access to a wider and more diverse pool of external capital as they look to refinance and rebuild. If ease of access is one leg that will do this, and viability of the asset class as an investment case another, then wider index inclusion is the third leg that will give developing economies a solid platform to grow.
1 Source: https://www.ft.com/content/9792d6f8-2423-4c04-9a65-31d8b0b4b5a8
2 Source: https://www.bloomberg.com/news/articles/2021-07-20/emerging-market-investors-pile-into-bonds-as-delta-spreads