Australian investors are in a better position than most to incorporate emerging market debt within their portfolios because they can take advantage of the close correlation between emerging market currencies and the Aussie dollar. A new research note shows how this works.
According to global manager GAM, when Australian investors leave unhedged their emerging market debt strategy, the return volatility is lower than in ‘hard-currency’ bonds and equal to that of global bonds.
GAM has produced a research note, ‘Emerging Market Debt for the AUD Investor’, which also points out that emerging market (local currency) yields are currently higher relative to AUD yields than at any time since at least 2003.
The research note was written by Paul McNamara, investment director, and Michael Biggs, investment manager, of GAM’s emerging markets bond team.
The authors say: “We believe that the characteristics of the EM local currency rates asset class for AUD investors are possibly misunderstood. If the returns are considered in USD terms (or hedged into AUD), the returns on EM local rates are more volatile than the returns on either EM hard currency bonds or global bonds.
“The local currency rates asset class is unique in that EM FX is very closely correlated with the AUD. For all the other asset classes we considered, return volatility increases if the returns are not hedged. In the case of local currency rates, the return volatility declines. If local currency rates are received one-third hedged rather than fully hedged, by our estimates the volatility of returns declines well below EM hard currency debt and is comparable (slightly below) to global bonds.
“The question of volatility is particularly relevant at present, as EM yields spread relative to AUD bonds have reached 15-year highs.”
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