Natsuko Waki London

Investors dipping their toes back into emerging markets are choosing hard currency debt, which – thanks to rich yields and expectations for a stronger dollar – is the developing world’s best-performing asset class this year.

The Institute of International Finance (IIF), which provides the most authoritative capital flows data, said emerging markets drew $25 billion (R262bn) from global stock and bond investors last month, after combined $55bn inflows in February and March. Bonds attracted almost two-thirds of the April flows, the IIF said.

Separately, Boston-based EPFR Global, which tracks unit trusts, said emerging bond funds had net inflows of about $500 million in the week to April 30, enjoying the fifth consecutive weeks of inflows.

But not all emerging debt fared well: dollar-denominated hard currency bonds attracted almost $300m, but those in currencies such as the rand and the Turkish lira saw outflows again, reflecting investors’ concern about currency weakness.

“People are not willing to take a high-beta fixed income view in terms of exposure to [local currencies] where most of the volatility is. So there’s more of a focus on dollar carry,” Fredrik Nerbrand, the global head of asset allocation at HSBC, said. “It doesn’t mean we want to necessarily buy all [emerging market] credit – I suggest higher grade [rather] than lower grade. But valuation buffers in [emerging market] are sufficient in relative terms to offset high headline risks.”

Hard currency debt is the top-performing emerging market asset this year, rising more than 5 percent to beat emerging and developed equities, as well as most high-grade and junk bonds in developed markets.

Dollar-denominated bonds give investors a uniquely high interest rate without the risk of local currency volatility. And appreciation in the dollar adds to returns. Local currency debt has only gained 2.8 percent this year in dollar terms.

Banks estimate there is a historically high pick-up in yield of 100 to 125 basis points for those buying emerging sovereign debt, compared with Western corporates with comparable ratings.

“You get paid over 1 percentage point for owning equivalently rated sovereigns in emerging markets compared with US corporates. Investors are becoming more enthused about emerging markets,” Richard House at Standard Life said. – Reuters