What Makes Emerging Market Debt Tick? (CFA Institute)

A recent CFA Institute post noted that emerging market debt has been gaining popularity as a fixed-income asset class in recent years. To begin with, the post pointed out that the emerging market debt asset class consists of the following types of bonds:

1. Sovereign debt issued in major currencies, mostly the US dollar
2. Sovereign debt in local currencies, and
3. Corporate debt in major currencies, mostly the US dollar.

The first emerging market bonds were US dollar–denominated sovereign debt that came into existence as a way for lenders to recoup some of their defaulting loans to Latin American countries in the late 1980s as part of the Brady Plan (named after then US Treasury Secretary Nicholas Brady who led the initial negotiations). Being US dollar-based, the bonds trade off the US Treasury yield curve as a “spread product” with a return that should offer investors additional compensation over US Treasuries for the extra risk involved.

Local currency sovereign debt issuance has since grew much faster than US dollar–denominated sovereign debt. In addition to country risks, local currency sovereign bonds are also exposed to currency risks while the additional risk with US dollar–denominated corporate debt is corporate credit risk.

The post concluded by summarizing the factors that make emerging market debt tick are:

1. Country risk, mostly driven by fiscal conditions, e.g. internal balances as it is often known,
2. Currency risk, driven by balance of payments or external balances and the resulting reserve positions, and
3. Corporate credit risk, e.g. company balance sheets.

To read the whole article, What Makes Emerging Market Debt Tick?, go to the website of the CFA Institute.

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