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Emerging market credit spreads have shrunk by 30% since the financial crisis, while the spreads on many developed market bonds have widened significantly. Why have emerging market bonds done so well?

Luz Padilla, portfolio manager of the DoubleLine Emerging Markets Fixed Income Fund (DBLEX / DBLENX) made a strong case for emerging market bonds during a conference call Learn Bonds participated in on October 9th, 2012.

Flight To Quality

Ironically, many emerging market bonds are now considered safer than their developed market equivalents. Emerging markets are growing, and many

DO NOT PASS (Photo credit: krossbow)

emerging market governments are showing tremendous financial restraint. Here are three factors that are leading to higher credit ratings for emerging market debt, and why you may want to consider investing (the 4th comes later):

1. Growth: Emerging markets are expected to grow at 4 times the rate of developed markets. In 2012 72% of global GDP growth is coming from emerging markets.

1. Financial Responsibility: Emerging market economies are much tighter with their spending than developed economies. Fiscal balances (the difference between government revenues and spending) are smaller and as a result, they have manageable debt loads. The average debt to GDP ratio is 34% in emerging market economies. This is in sharp contrast to developed markets, where the average is closer to 100%.

1. Rating Improvements: Due to the two factors mentioned above, the credit ratings of many emerging market have improved. 60% of emerging market corporate debt is now rated investment grade. That compares to less than 40% in 2000. The low default rates seen since the global financial crisis has also reinforced investor confidence in the asset class.

These factors have caused spreads to come down significantly. Since the financial crisis, emerging market spreads have tightened by 30%. During that same time developed market spreads have widened by 3 times. Countries like Mexico and Brazil now trade at a lower credit spread than many European developed countries like France.

Do emerging market bonds have more room to rise?

Since emerging market debt has performed very well over the last several years, some investors are concerned that the market is overheating. They think that “dumb money” is chasing the higher yields offered by emerging market debt without taking in account the risks. This perhaps accounts for some of the demand, however an increasing portion of buyers are local and institutional. This brings us to the 4th reason you may want to consider emerging market bonds:

4. New Sources of Demand: Emerging market financial players, pension funds and insurance companies are now large buyers. Additionally, more traditional institutional buyers are getting involved. As the supply of investments that offer high credit quality and good yields in the US has disappeared, many institutions are expanding their horizons to include emerging market debt.

Much of that money has gone into emerging market government debt. Luz Padilla of DoubleLine indicated in the call that while there may be less opportunities in emerging market government debt, there are still opportunities in emerging market corporate and local currency debt.

The DoubleLine Emerging Markets Fixed Income Fund is LB Rated and you can find our report here. I have also included the slides from the presentation below: