Big emerging market bond managers, including Aegon USA Investment Management and JPMorgan Asset Management, are reducing their exposure to the riskiest positions in developing-world dollar debt. This comes as spreads on these bonds have tightened to just 170 basis points over Treasuries, the narrowest since 2007, and investors anticipate higher interest rates for an extended period. Over the past year, dollar bonds from developing countries returned 1.4%, but this resilience now makes investors uneasy given rising Treasury yields and oil prices above $100.
Fund managers are pivoting to stronger credits and local-currency debt. Neuberger Berman's Gorky Urquieta has scaled back high-yield names such as Ecuador, Dominican Republic, and Zambia, describing the current environment as a "retrenchment mode." Similarly, PPM America's Matt Graves has extended duration with stronger borrowers like Morocco and trimmed positions that had rallied, such as Angola. Other managers, like Fernando Grisales of Schroders, are finding value in investment-grade bonds that have been impacted by the Treasury selloff, picking up Saudi Aramco notes and Mexico's dollar bonds.
JPMorgan Asset Management is also increasing its focus on local markets, indicating a reduced appetite for credit risk in dollar-denominated EM bonds. Despite surging Treasury yields and oil above $100, emerging-market dollar bonds have largely held their gains, a factor that makes some managers nervous due to the historically tight spreads. Bloomberg Intelligence highlights Federal Reserve policy as a key threat to hard-currency EM debt in the fourth quarter, warning that narrow spreads could amplify country-specific shocks. Caution is also evident in fund flows, with the largest ETF tracking hard-currency emerging-market bonds experiencing significant outflows.
Despite the shift away from risky dollar debt, local-currency emerging market debt has performed well, up 0.9% on average this year. A broad gauge of developing-world stocks has also climbed more than 23%, outperforming developed-market equities. High domestic rates and firm commodity prices have kept markets such as Brazil and Colombia attractive to investors. The overall trend indicates that while investors remain engaged with emerging markets, they are adopting a more selective approach, favoring higher-quality sovereign issuers and local currency assets amidst rising US yields.
