Corporate and government debt (or bonds) issued by emerging market countries makes up an estimated 10% of the global bond market, according to investment firm TCW Group. Yet, the average investor has only 3% to 5% of his or her bond portfolio allocated to emerging markets, meaning that most Americans are underinvested in this growing sector.
Many investors have misconceptions about the safety and credit quality of emerging market debt. In reality, many emerging countries have stronger balance sheets than their developed world counterparts. For example, Singapore has the coveted AAA rating (higher than the U.S.), while Qatar, South Korea, Malaysia and Mexico are all rated an impressive AA or A. Brazil, Russia, Peru and Colombia’s ratings fall into the respectable “investment grade” category.
Emerging market countries often have less of a government debt problem and stronger balance sheets than we do. “The average debt-to-gross domestic product ratio in the emerging markets is around 35%, while those in developed countries are hovering around 100%,” according to research by Investment News.
All of this argues in favor of adding emerging market bonds to a diversified portfolio. “In a well diversified fixed income portfolio, it certainly deserves an allocation” says Luz Padilla, Senior Portfolio Manager at DoubleLine Funds. She suggests allocating 10-15% of your fixed income portfolio to emerging market bonds.
Research confirms that adding non-U.S. bonds, whether issued by emerging or developed countries, to a stock-and-bond portfolio is likely to add value and improve diversification because of the low correlation with other assets. It clearly makes sense from a performance and yield perspective to venture beyond U.S. borders. Over the past 15 years, the U.S. bond market has been the world’s top-performing bond market only twice, according to T. Rowe Price data.
While performance, as with other asset classes, can be volatile, emerging market debt has certainly earned its place at the investment table. “Emerging markets fixed income has only had negative returns for three years in its 20-year history,” says Padilla. An added bonus? Emerging market economies are expected to grow faster this year than other regions, which suggests improving balance sheets.
Conclusion: Every investor’s portfolio is unique, and should be customized to meet his or her financial needs and objectives. But emerging market debt is certainly worth considering for long-term growth and income portfolios, as it can add diversification, income, and return benefits a part of an overall fixed income portfolio.