Emerging Markets Debt: A Case for Latin America

Executive Summary

With $13 trillion of investment grade corporate and government bonds having negative yields, fixed income investors are increasingly looking at higher yielding emerging market debt.

Emerging market debt is one of the most diverse fixed income asset classes in the world with exposure to both US Dollar denominated and local currency bonds in Latin American, Asian, African and Middle Eastern economies. Latin America currently represents 33% of the total Dollar denominated debt in emerging markets. With many emerging market bonds still not included in major benchmark indices, active managers can gain an edge over their passive counterparts through security selection in their investment process.

In an ongoing effort to better understand the risks and complexities associated with emerging market investing, LM Capital has produced a three-part series to highlight the importance of regional specialization coupled with a risk minimization framework in emerging markets.

In this first part, we focus on the relatively high correlation across different regions within emerging markets and how the changing economic and demographic fundamentals make Latin America an attractive investment for the future.

Emerging market economies have evolved rapidly over the past two decades, especially in the Latin America region (LATAM). Emerging markets have decoupled from the economic cycles of developed economies and are able to withstand negative market events better than in the past. Across Latin America, the following factors are attractive for investments: improved economic fundamentals, an increasing pension industry, a young population with an expanding middle class, and cheap corporate valuations. Furthermore, a dovish Fed is putting less pressure on foreign corporations which are largely financed with US Dollars.

These trends in emerging market economies present a new opportunity for actively managed Emerging Market Debt (EMD). Although the performance of this asset class is highly correlated to systemic forces (e.g., strength of the USD/Euro/JPY, monetary policy in developed markets), the business cycles of specific EM economies have important idiosyncratic drivers. We believe risk minimization through security selection is a better approach to exploiting higher risk-adjusted returns as compared to regional diversification. At LM Capital, we attempt to identify investments that are decoupled from systematic drivers thereby harnessing diversification benefits from these idiosyncratic investments.