EM Equities vs Debt: Same, Same, but Different?

Evaluating the Lure of Emerging Markets

July 2020. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Some EM asset classes are highly correlated, to the point they can almost be considered interchangeable
  • EM equities and hard-currency government debt are highly correlated to US equities and bonds
  • In crisis times, all EM exposure is sold off and fails to provide meaningful diversification benefits

INTRODUCTION

Dreaming of vacationing in Europe conjures images of towns and villages rich in architecture and history, delicious food and delicate wines, high mountains and sandy beaches, and an unparalleled depth in music and art. Some Europeans, notably the French, primarily stay in their own countries as they see little need to go elsewhere. For tourists across the globe, Europe is the best option for experiencing so much in a short amount of time.

In stark contrast with its success as a tourist destination, European equity and fixed income markets create far less excitement for global investors. Bonds can almost be disregarded as their yields are either negative (Germany) or do not seem to reflect country risks (Italy). Stocks require economic growth, but that growth is challenging to achieve when demographics are turning negative. The US seems better positioned from an economic perspective, although stocks trade at high valuations that give rise to a different concern.

Some investors are therefore turning to emerging markets (“EM”) equities and debt. The typical on-going arguments for EM are that two-thirds of the world’s population is living there and that China and India will be the twin growth engines of the global economy in the 21st century. Well-respected publications like The Economist regularly feature this theme on their cover page:

  • Is China Winning? (April 2020)
  • The New Scramble for Africa (March 2019)
  • Planet China (July 2018)
  • Can Anyone Stop Narendra Modi? (April 2014)
  • Brazil Takes Off (November 2009)
  • The Rise of the Gulf (April 2008)
  • Surprise! The Power of the Emerging World (September 2006)

However, investing in emerging markets remains a complex task. EM countries span a wide range of political regimes from capitalist to communist, EM equities are dominated by a single nation, and EM debt comes in a variety of forms, issued both by governments and corporates