With the advent of an ever-more technologically innovative and globally connected capital markets sphere, fixed income emerging markets (EM) have demonstrably become an increasingly appealing area of interest for investors.
As trading of these assets has become easier and market conditions are predicted to fall in line, the industry has seen a swathe of new EM-focused hires, increased attention paid to developing markets’ performance, and enhanced offerings from providers.
Across the industry more attention is noticeably being paid to this universe as the expectation of lowering dollar rates looms nearer, with the potential for new liquidity opportunities proving irresistibly appealing to market participants.
“There is a structural case for emerging markets, and it is set to remain a core part of the fixed income opportunity set,” asserts John Espinosa, head of sovereigns and portfolio manager for Nuveen’s global fixed income team.
“It is currently 10% of the Bloomberg Global Aggregate Index, which is a bellwether that captures the world of global fixed income.”
The trend is our friend
The consensus appears to be that this is firmly an area where the best is potentially yet to come. As Jean-Charles Sambor, head of emerging market debt at TT International Investment Management tells The TRADE: “The emerging markets fixed income sphere is recovering, and we expect inflows back to the asset class after years of investor exodus.”
Dan Burke global head of emerging markets at MarketAxess and former global head of credit e-trading at Standard Chartered, agrees, confirming that from his perspective what started as a challenging year for EM is now turning into a favourable backdrop thanks to inflation starting to moderate globally.
Burke explains: “At MarketAxess, we have seen huge growth in local markets coupled with an increase in larger trade sizes. In Q1 of this year, our local market volumes were up 23% year-on-year, while trades larger than $25 million were up 23% in 2023. I expect this trend to continue throughout the remainder of the year as the macro backdrop improves and rate cuts are all but guaranteed.”
Notably this is an area characterised by its ebbs and flows, continually impacted by major global events including the pandemic, war in Ukraine, and the intense tightening of monetary policy.
Speaking to The TRADE, Niels Nooy, EM execution specialist at Liquidnet, says: “I have been involved in emerging markets since the early 1990s and have seen many market cycles over that period […] Traditionally, with higher interest rates, capital tends to leave emerging markets because there’s less of a need for the extra yield pick-up. Now, there is clearly more value in emerging markets in terms of real yields, so the timing is probably right for an improvement in sentiment at least, and maybe for some funds to flow back into emerging markets fixed income.”
Since last year EM fixed income was expected to do well however, currently market changes are yet to pass.
Geoff Yu, senior EMEA market strategist at BNY, explains that though the iFlow data showed that in Q1 some of the best performing regions were in frontier markets as investors rewarded reform intent, overall, despite a positive future outlook, [EM] hasn’t done as well as predicted.
“It’s fair to call it lacklustre […] the reason ultimately is because dollar rates are still quite high and then see if they come down and we don’t see US yields coming down aggressively yet for example,” he says.
However, firms are continuing to gear up for future flows into the area despite slow developments, recognising the consequences of not harnessing the potential of EM bonds and biding time for what many believe is the inevitable.
“Looking at the second half of the year, emerging markets stand to do very well, especially those without direct exposure to US politics or global politics in general […] the bottom line is we need to see a clear trigger, and then on a risk adjusted basis, the EM fixed income sphere should be one of the best-positioned asset classes for the second half of the year and beyond,” says Yu.
Diversify to liquify
There are undeniable, established upsides of this asset class which investors are keen to capitalise on once the market is primed. One of the key ways that emerging market fixed income is poised to become an increasingly essential part of investment portfolios going forward is of course for diversification purposes.
“The significance of EM cannot be understated, especially as the macro backdrop continues to improve,” asserts Burke. “The rise of capital flows from the Middle East are one example of the growing importance of EM, and as these markets grow, they will continue to allow greater diversification of EM portfolios.”
Not only is the asset class a highly efficient way of broadening scope, but emerging market bonds have also historically offered higher yields than developed markets and as such can help reduce the overall volatility of a portfolio – an increasingly important factor given the current state of play.
Speaking to the key advantages, Sambor explains: “We believe it is a particularly good fit for active investors with a contrarian slant. EM investment styles and processes are becoming increasingly bifurcated between large passive or quasi-passive investors and very nimble ones that can exploit a volatile environment and sudden changes in flows or investor asset allocations.”
Moreover, there is no looking back when it comes to emerging markets being increasingly integrated into the global economy and the continued promises of more aligned international processes.
These factors “improve visibility and attract a wider variety of investors,” asserts Flavio Paparella, managing director at BTIG global emerging markets fixed income, who adds that “local currency bonds are now as regular investments as hard currency bonds”.
Speaking to the increasing importance of emerging market bonds for desks going forward, Paparella highlights that the rapid economic growth of developing countries can re-value bond prices over time, enabling investment and infrastructure opportunities which further increase demand for bonds.
“Many emerging markets are implementing structural reforms to improve their business environment and the economic growth that comes with it can positively affect the bond markets,” explains Paparella. “Investors are challenged to be mindful about where to invest within emerging markets.”
Despite these positives, currently, markets are in a bit of a waiting game when it comes to the space, and are, for now, anticipating an inflection point, say experts. But, of course, there is more to come, and the market is prepping.
Espinosa affirms that though for the last five or so years EM has had an overhang – related to events such as the pandemic, geopolitical risks and rising rates in developed markets which has placed pressure on the asset class – the market is very close to the tipping point where those factors are waning.
“Traders are of course looking to maximise opportunities clearly and looking for an upside but how do you reconcile that with a challenging political environment or geopolitics? That’s always going to be an issue but our iFlow data shows that the EM fixed income sphere is just waiting for a trigger,” adds Yu.
Shifting strategies
Seemingly in preparation for this both firms and providers across the market are focusing in on how to take advantage of the space most effectively. One key way has been through new hires to push into new regions and establish internal processes.
“EM is a mosaic of sub-asset classes rather than a unified universe. It requires very different skills to trade EM FX versus rates or credit as the liquidity and price discovery mechanisms vary markedly. Desks that are designed to be nimble and opportunistic should be able to provide alpha through skilful execution,” comments Sambor.
In addition, several technology vendors have been incorporating EM bonds and enhancing their offerings in other ways to service client demand.
“As it is a very broad and growing segment of the market, it is driving managers to beef up their talent and resources. EM fixed income offers lots of benefits to clients from a risk adjusted return perspective, but it is not something you can beta efficiently. It requires resources to be able to invest effectively across a universe of 70 different countries,” explains Espinosa.
Various hires, new initiatives, and offering enhancements in the space have peppered the headlines in recent times. Recent examples include Fernando Ortega having been appointed head of emerging market sales at KNG Securities as part of its strategy of expanding in emerging markets across all areas of its business, and Paparella who joined BTIG’s fixed income group in July 2024 to help expand the firm’s presence across Latin America.
He explains: “Recently, more firms have expanded their emerging markets divisions in response to growing investor demand for diversification and higher-yielding fixed income assets. This involves hiring talent with specific skillsets and investing in dedicated infrastructure, including foreign offices, developing new platforms, and expanding marketing efforts.”
Various vendors have also continued to enhance their scope to meet investor demand for greater access to new jurisdictions, such as MarketAxess’ enhancement of its Open Trading platform to include a functionality focused on the local currency bonds of Poland, Czech Republic, Hungary and South Africa, and JP Morgan including Indian government bonds in its emerging market debt index.
Demonstrably, the asset class is growing with a swathe of firms moving to position their teams in the strongest position possible.
“Bank trading desks continue to add human and algo trading resources to the sector, and that paired with the increase in alternative liquidity providers is proving that EM can provide unrivalled liquidity,” asserts Burke.
A stock picker’s paradise
The emerging market fixed income sphere is not one, simple and homogeneous set. As an asset class it is a universe full of intricacies and niche knowledge. Though bolstered by rebounding economies, increasing globalisation and accessibility, what is key is knowing where – and how – to maximise opportunities.
“In this world, it is about selectivity. Emerging market fixed income is a bit of a stock picker’s paradise,” declares Yu.
But just how is this being enabled? As the EM investment community expands, of course so does the ecosystem which surrounds it.
The space, which by nature is fragmented both geographically and in terms of instruments, and thus complex, is being democratised through the enhancement of the systems. Namely, technological innovation through automation and electronification.
Nooy tells The TRADE: “Different regions and countries have different domestic rules about what you can and can’t do and what you can trade. On the currency side, you need to be able to settle locally which includes custodians, so it is not easy.”
Over time, as more of these sectors start getting traded electronically via different platforms the interest will continue to increase despite the fact that EM is lagging slightly behind developed markets.”
Of course, the extent to which e-trading is prevalent across emerging markets, and the processes which interact with it is yet to reach the same levels.
Burke confirms that “There has also been an increase of alternative liquidity providers within EM, specifically systematics and ETF providers. We’ve also seen an increase in portfolio trading activity in the market.”
He adds: “Clients are turning to our protocols like request-for-market (RFM) to execute larger trades. During the recent volatility in early August, our RFM volume was up 103%.”
When it comes to trading you must be acutely aware of what you’re dealing with, and emerging markets require particular focus. The minutiae of each jurisdiction and region in question requires a thoughtful approach.
Speaking to the specifics when it comes to the actual trading itself, David Everson, head of fixed income trading EMEA at Liquidnet, explains: “EM has always been an important part of our business as our dark pool protocol is well suited for trading those harder-to-trade names. If you look at the more illiquid bonds in the EM market, a dark pool is appropriate as you want to minimise information leakage and get trades done without leaving a footprint.
“The EM market is so vast. If we consider the more liquid bonds in the EM market, it is full of potential. One of our protocols – Rebalance, our dealer-to-dealer electronic business – is suited for that. We see smaller trades in Rebalance while our dark pool is better suited to less liquid bonds and larger-sized tickets.”
Evidently, the emerging market fixed income sphere is trading. As Nooy adds: “In our new issue trading platform, our primary trading protocol, we’ve definitely seen a pick-up in emerging market issuance, which had been quite absent in the last year or two.”
For EM FI teams to be truly successful, what is required is comprehensive support in the form of efficient, up to date, and importantly innovative systems. It is a complex world which requires effective tools for risk management, data and information, to make the most of local processes and to take in relevant regulations and compliance requirements.
Paparella explains: “This complex set of needs has naturally driven the growth of the vendor industry […] In line with broader market trends, emerging markets benefit from innovative technology and platforms that enhance visibility and transparency. The increased availability of information is a game-changer.”
As a distinct asset class, EM fixed income is well positioned for a rebound as the investment community seeks alternatives offering higher risk and returns while maintaining appropriate levels of safety and transparency.”
As institutions demonstrably expand their remits through stronger teams and enhanced solutions, the message is clear – we’re getting ready.
This asset class is perhaps boundless, as the markets (and governments) in question continue to evolve and face increasingly unpredictable times. To maximise opportunities in the space, the time for preparation is now.