(Systematic) Investing in Emerging Market Debt

Abstract

We extend the analysis of systematic investment approaches to emerging market (EM) fixed income. We focus on hard currency bonds issued by emerging sovereign and quasi-sovereign entities. We find that systematic exposures linked to carry, defensive, momentum, and valuation themes are well compensated and lowly correlated in EM markets. A transaction-cost and liquidity aware long-only portfolio generates an Information Ratio above 1. We further show that excess of benchmark returns for a broad set of EM managers are (i) largely explained by passive exposures to EM corporate credit excess returns and EM local currency returns, and (ii) have nontrivial macroeconomic exposures (growth, inflation, volatility, and liquidity). A systematic approach to EM debt may be a powerful diversifier.

TOPICS: Emerging markets, currency

Key Findings

• • We find that a systematic approach to active risk taking ‘works’ in emerging market (EM) fixed income. Exposures linked to carry, defensive, momentum and valuation themes have been well compensated in EM markets.

• • We further find that excess of benchmark returns for incumbent EM managers contain a lot of traditional beta and significant macroeconomic sensitivities.

• • There is potentially a large diversification benefit for a well-crafted systematic long-only portfolio of EM bonds.