Emerging-Markets Debt Stands Out

The well-chronicled balance sheet deterioration of developed sovereign countries has led investors to perceive emerging market sovereigns, and their locally domiciled corporate debt, as increasingly attractive risk-adjusted investments. In some cases, these asset classes are accounting for an increasing percentage of portfolio core holdings. In simplest terms, this is both a recognition of, and reaction to, the fact that, in many developed countries, debt to GDP ratios are over 100% and growing, while developing economies boast ratios close to 40%.

The Morningstar Global Sovereign Ex-US Index year-to-date total return stands in sharp contrast to our Emerging Markets Sovereign Index, and its sister, the Emerging Markets High Yield Corporate Index. The Global Sovereign Ex-US measures--in U.S. dollar terms--the performance of the largest European and Asian developed sovereign issuers. The emerging market indexes measure the U.S. dollar-denominated sovereign and corporate markets in Latin America, emerging Europe and Africa, and Asia (ex-Japan).

At the height of the credit crisis in 2008, sovereign and corporate emerging market debt--as measured by the indexes--earned yield spread premiums to U.S. Treasuries of over 7% and 20% percent, respectively. Today the premiums are close to 2.5% and 7%, and below the long-term averages. It reasons that arguments for additional outperformance lack technical merit, and a higher correlation to the equity averages leave it suspect to a double-dip recession.

Future performance is anyone's guess--but if demand has been driven by the contrasting sovereign balance sheets, there is little to suggest that driver will wane anytime soon.

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