Investors plotting their return to emerging markets after this week’s selloff should look at unappreciated longer-dated debt in local currencies.
That’s according to HSBC Holdings Plc and UBS Group AG, which see it as the best way to milk higher real rates in developing nations, even as the dollar’s newfound tailwinds may challenge local currencies.
HSBC strategists led by Andre de Silva reckon cautious positioning has provided plenty of scope to add juice to the bull run in emerging-market local debt.
Investors had already begun to pare back exposure to long-dated debt funds this month in anticipation of an uptick in developed-market government bond yields spurred by hawkish monetary chatter. That, they say, has left investors cash-rich and underweight long-duration government bonds in local currencies — pushing back against bears who say indiscriminate capital flows have compressed premiums, reducing the market buffer for selloffs.
HSBC favors 20-year debt in Indonesia and Malaysia, 13-year obligations in India and South Africa, and is bullish 10-year notes in Brazil and Mexico.
Picking developing-nation bonds in their own currencies earned 16 percent in dollar terms this year, versus 10 percent in 2016, according to UBS. Hard-currency bonds have gained 9 percent while Treasuries have offered 3 percent so far in 2017.
UBS recommends buying long emerging-market bonds in local currencies using low-yielding currencies from commodity exporting nations such as Australia and Canada. Recent emerging-market headline inflation readings weighted to index benchmarks are at an all-time low, according to Bhanu Baweja and Manik Narain. That makes the strategists more comfortable with duration risk.
“The investment opportunity we like the most in EM is long local rates financed with low-yielding commodity currencies in DM,” Baweja and his colleagues wrote in a note to clients. “We like taking inflation risk in EM.’