Investors who gave up on emerging markets in recent years missed out on a significant recovery, as both local and external EM debt indexes1 have gained around 10% over the past 12 months. While replicating such strong returns over the next year seems unlikely, EM local and external bonds may provide better yields than developed market alternatives, as the chart shows. Going forward, we expect developed market real yields to be capped by low potential growth and persistently high debt burdens.
Emerging markets’ resilience is creating an upward trend that investors have just recently started to price in to EM assets, and valuations appear attractive compared with DM bonds. The wide real-yield gap also means EM debt will likely be less sensitive to higher rates in developed markets.
Emerging markets do, however, remain vulnerable to a turn in risk sentiment, and our generally positive view on EM is not an “all-clear” signal. We recognize that risks persist, but believe they are much diminished now compared with the fourth quarter of 2016 and less likely to materialize over the next year.
In sum, while caution is warranted, we think now may be a good time for investors to consider adding diversified EM allocations to their portfolios.
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