Fixed Income

EMD Relative weekly notes: Week Ending February 21, 2020

James Barrineau

James Barrineau

Head of Global EMD Strategy

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Index Evolution

Indexes are the lifeblood for investors seeking to objectively analyze how they are doing relative to asset classes as a whole, and to other investors within that asset class. Yet a myopic focus on performance of an index can tend to obscure the forest for the trees.

In EMD, we often see incremental but meaningful shifts in the percentage of indices that are investment grade, for example. The local currency index quite often welcomes new investors, changes relative weights and – starting next month – will welcome in the behemoth of China, incrementally over a period of months to a weight of 10%. That means correlations will shift, regional dynamics will change, and returns will ultimately be dependent on slightly different drivers. 

This particular change has been well flagged, and investors have anticipated it for some time. But investors tend to lose sight of important changes that evolve more subtly.

We are in the midst of one such alteration that is very important for investors, particularly at the current juncture. The duration of the sovereign dollar index has soared in the past year, as shown below. As low rates in the developed world become further entrenched, EM issuers have logically taken advantage by aggressively issuing longer dated debt.

Figure 1: EM sovereign investment grade effective duration


Source: Bloomberg and JPMorgan. The chart depicts the duration of the JPMorgan EMBI Global Diversified Index for the period of January 2, 2015 to February 20, 2020. Indexes are unmanaged. Investors cannot invest directly in any index. Actual results would vary due to, among other things, fees and expenses.

For investors this is a double-edged sword: while this reduces credit risk, it dramatically increases interest rate risk – and at a time when long dated treasury bonds offer a measly sub-2% yield. While it is hard to argue now that interest rate risk should ring alarm bells as global growth slows and coronavirus fears evolve, at some point EM investors will be forced to weigh those relative risks in a different manner, and the fallout could be jolting.

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.