According to Daniel Wood, Senior Portfolio Manager EMD Local Currency at NN Investment Partners, after an eventful start of the year, it is a good time to review how Local Currency has performed both on a stand-alone basis and against the other sub-asset classes in emerging markets. In his view, this year can be divided in two sentiments:
31 December - 25 January: an optimistic start to the year
Inflows into Emerging Markets Debt (EMD) were strong in this period. Optimism was high, driven by synchronized global growth and elevated investor appetite for EM exposure. During this period LB returned 5.1% in USD unhedged terms, compared with 3.3% for LC and 0.25% for HC. To him, two things stood out during this period:
n a risk-on environment, LC enjoyed strong positive returns over the period, with the FX component of the return only narrowly lagging that of LB. "At this stage, investors in both LB and HC were not punished excessively for holding higher duration, in spite of rising developed markets (DM) rates risk signalled by the higher US Treasury yields across the curve." He says.
26 January - 31 May: markets turn sour
As market fears began to grow about rising trade and geopolitical risks and as economic surprise indices in both Europe and EM tracked lower, asset prices began to fall. During this period HC spreads widened from 263bp to 344bp, contributing to year-to-date total losses of 4.06% for the asset class. Having previously demonstrated strong resilience, yields on LB also tracked higher, rising by over 35bp to 6.41% at the end of May. From its 25 January peak, LB dropped more than 9%, bringing total year-to-date losses to 4.55%. Emerging market equities also registered heavy losses, falling more than 10% from their January peak. In contrast, LC ended May down only 1.81% year-to-date, again demonstrating resilience to a more volatile global market environment.
Why has LC been so resilient to recent market dislocations?
Wood believes that the low duration of the LC benchmark would insulate the asset class from the growing risk of rising developed market bond yields and that the more favourable, higher quality currency composition of the LC benchmark would deliver strong returns in favourable market conditions while offering some protection to investors if risk sentiment deteriorated. This has been for three main reasons: