Investing in emerging market debt does carry more risk than developed market bonds, however the dynamics are different.
Fixed interest (bond) investments are seen as low risk, however many accept that the returns in a rising interest rate environment will be challenged. A small upward rise in interest rates could deliver negative returns, and as an asset class perceived as low risk this starts to make it less attractive for investors.
One area of the market investors are turning to is Emerging Market Debt. The argument is that away from seeing economies as a homogenous group there are some strong economies. These economies show signs of greater growth when compared to developed economies. They have solid fundamentals (lower debt), better demographics and higher yields.
Accessing the debt is via two routes – hard currency which tends to favour less developed economies and local currency. Local currency is shown to outperform hard currency over the long term and countries using local currency tend to be stronger. The worry is that with the dollar strengthening, countries using hard currency will struggle to meet the repayments and defaults may be greater.
For many investors this means there is greater risk of volatility and this is true, there is also the question around whether investors should opt for local or hard currency.
Our approach has been to blend both currencies because they will perform differently and at different points of the economic cycle. One fund we have followed and use is the Baillie Gifford Emerging Market Debt Fund. This invests a minimum of 75% in local currency. Performance over hard currency has been poor in the last two years and we have recently had an update with the manager to understand more about what potential investors should consider before opting for this fund or any emerging market debt fund.