Investing in high yielding securities across emerging markets, rather than only in equities or debt, offers powerful diversification benefits. In this paper, Richard Titherington and Pierre-Yves Bareau examine the case for combining emerging market equities and debt for income.
- Emerging markets continue to drive global growth, and also represent an increasingly important source of income.
- Many emerging market companies are paying high and rising dividends, and the power of compounding means high yielding emerging market stocks have historically outperformed the broader market.
- With many emerging market countries in stronger fiscal positions than their developed peers, emerging market debt has become an increasingly mainstream asset class.
- Combining emerging market equities and debt in a single portfolio has the potential to improve risk-adjusted returns while providing more broadly diversified exposure across the emerging world.
- With fears of a 1990s-style emerging market crisis looking overdone, there currently appears to be a buying opportunity.
- We are overweight equities vs. bonds, but are finding attractive opportunities for income investors in both asset classes.
The great rebalancing
The most transformational change in the world today is the rebalancing of economic growth, from north to south, from west to east, from developed to emerging markets. The story of this rebalancing has become a familiar one: across the emerging world, people move from the countryside to the cities to seek higher wages, productivity grows, and the new urban dwellers become a new class of consumers.
As a result of the virtuous circle of development, emerging market (EM) growth is outstripping that of the rest of the world. Between 2010 and 2018, emerging markets are forecast to contribute 55% of global growth (Exhibit 1). According to the International Monetary Fund (IMF), 2013 is the first year in which emerging markets will account for more than half of world GDP on a purchasing power basis.
Emerging markets are powering global growth
For investors, emerging markets increasingly represent not only an attractive source of long-term capital growth, but an important tool in income portfolios. In the low interest rate environment that has prevailed since the financial crisis, EM debt has been sought for its higher yields, as well as for the fiscal strength of many issuers relative to their developed world peers. Meanwhile, with more and more EM companies paying strong and rising dividends, EM equities have become a sustainable source of income. Combining the two asset classes allows investors to access diversified streams of income and tap into EM growth with lower volatility than a pure equity approach.