Why Emerging Market bond funds could make sense
Emerging Market bonds generally offer higher yields than bonds from developed/industrialised countries. Not least due to their above-average growth and the increasing global economic importance of many Emerging Markets, their bonds also offer greater long-term earnings potential. At the same time, they can be a useful diversification for an investment portfolio. Nevertheless, no investment is without risk and Emerging Market bonds generally harbour higher risks and therefore require a little more care.
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A key success factor is a good selection of individual bonds. The latter requires a great deal of experience, expertise and constant observation of economies and financial markets. It therefore makes sense for investors to let specialised fund managers work for them and make such investments using an investment fund.
Emerging Market bonds, whether in local currencies, in US dollars or in euros, currently offer attractive yields and a good risk-return-profile. According to the investment specialists of Raiffeisen KAG, the current yields generally compensate sufficiently for the expected risks. However, this does not apply, or only to a limited extent, in the event of unexpectedly strong negative developments in the economy, inflation or geopolitics.
Raiffeisen KAG offers two Emerging Market bond funds that invest globally and sustainably:
• one bond fund that invests in hard currency bonds and
• one that invests in local currency bonds
Why two different funds? Because these two main categories of Emerging Market bonds have very different risks and return prospects.
Local currency and hard currency bonds
1) US yields point the way for hard currency bonds
The vast majority of Emerging Market hard currency bonds are issued in US dollars. They largely follow the price and yield movements of US government bonds and always trade at a more or less large yield premium to US government bonds. This yield advantage accounts for a large part of their attractiveness but is different for each country or issuer. It not only means possible additional yields compared to US government bonds, but also normally reflects a higher risk.
A key figure that summarises this risk or yield premium of Emerging Market hard currency bonds compared to US government bonds is the so-called EMBI spread. The spread currently quotes at around 340 basis points. This means that Emerging Market bonds in hard currency currently offer an average annual yield of around 3.4% more than US government bonds (over an average remaining term of currently around 6.75 years). In absolute terms, this currently amounts to around 7.7% p.a., which is a very attractive yield. This applies even more, as yields in the USA are likely to trend downwards in the coming year. However, the 7.7% mentioned only provides an approximate indication of the annual returns actually realised in the end. These are influenced by many other factors (especially bond price movements) and may ultimately be higher or lower.
The abbreviation EMBI spread stands for Emerging Markets Bond Index Spread. The EMBI spread is an indicator of the risk premium for Emerging Market bonds. It measures the interest rate difference between Emerging Market bonds and US government bonds and is expressed in basis points. The higher the EMBI spread is quoted, the higher the risk is perceived on the markets. This spread is currently quoted at the lower end of its long-term fluctuation range.
2) Yields and currency movements are important for clocal currency bonds
Local currency bonds follow US yield movements less closely but are primarily characterised by the national economic and monetary policy environment. This includes, above all, the key interest rates of the respective central bank, local inflation rates and the financial situation of the respective countries. For foreign investors, any returns – or, in the negative case, losses in value – are primarily influenced by the interest rate on these bonds and currency movements.
Current outlook for Emerging Market bonds
Interest rates on Emerging Market local currency bonds are currently around the long-term average, although the differences between individual countries are considerable. Significantly lower and, in most cases, further declining inflation rates and upcoming US interest rate cuts should provide good support for the bond markets. Emerging Market currencies are generally not expensive, but in many cases quite favourable.
A certain global slowdown in growth has already been priced into the markets for 2025. As long as there are no major surprises in the global economy, both local currency and hard currency bonds from the Emerging Markets should fare quite well in the coming year. Any returns are likely to come primarily from interest coupons and less from price or currency movements.
The biggest risk is probably a slide into recession in the USA next year (not currently expected). This would give a strong boost to bond prices for US government bonds (and cause yields to fall). However, experience shows that Emerging Market currencies could then come under pressure against the US dollar and the euro.
For hard currency bonds, there would also be two opposing effects: rising US bond prices would also push up the prices of emerging market hard currency bonds. At the same time, however, investors' risk appetite would decrease, and risk premiums would rise. This would mean price declines for Emerging Market hard currency bonds. It is difficult to predict which of the two effects will ultimately be stronger in such a case. However, it is positive for investors that the fairly substantial interest income provides some protection and a buffer for returns even in such a negative scenario.
Are international investors returning?
Overall, the positioning of foreign investors can also be seen as positive for the market. In recent years, they have withdrawn a lot of capital from Emerging Market bonds denominated in local currency. This means a fairly manageable risk of further capital outflows (with corresponding downward pressure on prices) and, on the other hand, opens up upside potential if foreign investors start to increase their exposure to Emerging Market local currency bonds again.
Careful selection and diversification are important
For Emerging Market bonds (both in hard and local currency), a very careful selection of countries and issuers, as well as good diversification, is indispensable. This is why investment funds, with their portfolio diversification, are particularly suitable for this purpose.
Investing sustainably in Emerging Market bonds
The product range of Raiffeisen KAG includes two investment funds for risk-conscious investors who want to take advantage of the long-term return opportunities of Emerging Market bonds while investing sustainably. This allows fund investors to support the transition to more responsible economic practices in Emerging Markets.
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Raiffeisen-Osteuropa-Rent
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The Fund Regulations of the Raiffeisen-Osteuropa-Rent have been approved by the FMA. The Raiffeisen-Osteuropa-Rent may invest more than 35 % of the fund's volume in securities/money market instruments of the following issuers: Poland, Türkiye, Hungary.
Related topic: Promote the ESG improvement of the EM bond market