Investors’ On-Off Relationship With Emerging Market Debt

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Investors’ on-off relationship with emerging market debt (EMD) was again on display during much of 2016: annual performance reached double-digit heights by September, before falling back in the three days following the US elections. Despite this seesaw pattern of returns, EMD finished the year as one of the best performing fixed income markets, underscoring the merit of having a strategic allocation to the asset class. Less obvious is what, if anything, investors can do to reap consistently more of the gains, and less of the volatility. The reasons for investing in EMD are becoming increasingly relevant in today’s environment. Investors more than ever need income to match liabilities, and traditional developed market fixed income alone…show more content…
All of them can impact significantly the performance and risk profile of EMD assets. Second, the diversity of the asset class should mean more attendant alpha opportunities for investors, but the changing nature of the performance drivers make alpha generation less straightforward than it seems. Finally, the asset class is particularly vulnerable to short-term surprises, as evidenced last year by November’s US elections. We believe EMD differs from traditional developed market fixed income in several ways (see the chart below), and accommodating for these differences is an important step when investing in the asset class. Different dynamics Seeking more durable EMD returns How EMD differs from traditional fixed income How to adapt the investment process Implementation challenges The composition of the asset class and the underlying return drivers change more frequently Dynamic asset allocation to adjust to changing regimes Keeping transaction costs in check Investment universe is more expansive, diverse and complex, with markets and securities reacting very differently to global forces Actively incorporate complexities into selection process Understanding, measuring and managing the associated risks Performance is more vulnerable to event risk Manage drawdown effectively Hedging positions in real time and in a cost-effective manner Source: BlackRock, February 2017 These differences can have an

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