Emerging economies are seen as having a better economy and ability to pay, thus the migration in funds.
Thanks to the rise of short term interest rates in the U.S, bond fund managers are increasingly migrating towards debt markets in the emerging market and to non-agency backed residential mortgages, which they say should offer better returns since they have greater potential for gains.
Fund managers from BlackRock Inc, AllianceBernstein and Thornburg Investment Management are all bracing for an interest rate hike by the U.S. Federal Reserve.
Rising interest rates will make U.S. high-yield debt unattractive since municipalities and highly-leveraged companies will find it more difficult to roll over their debt costs.
The debt market in emerging economies, including in countries such as Mexico and Brazil who are undertaking structural reforms, look promising.
“We are in a phase where diversification is going to be a big strategy” since the hike in interest rates will reduce the attractiveness of domestic assets, said Gershon Distenfeld, portfolio manager of the AllianceBernstein High Income fund. “Our fund was up 15 percent last year and we don’t see that happening again.”
40% of Distenfeld’s portfolio has been allocated to the U.S., in comparison to the previous year figure of 75%. Distenfeld is gravitating towards both dollar and local-currency denominated securities in Brazil.
Of significance is the fact that, the U.S. high yield bond market, by comparison, is “on the rich side now,” said Distenfeld.
During Tuesday’s stock-market sell-off, high-yield debt instruments, suffered a bear vertical decline, as investors moved to safer assets, while debt from emerging-markets have retained more of their value.
With the U.S. Federal Reserve hiking short term interest rates for the second time in 3 months on March 15, and with the expectations that it could further hike rates two or three times in 2017, analysts and investors feel these hikes are eating into the returns of bond funds.
As per Bob Miller, BlackRock Total Return fund’s lead portfolio manager, with the peso regaining its value following a steep decline following Donald Trump’s surprise win of the U.S. presidential elections, Mexico’s economy looks pretty attractive.
Despite the negativity surrounding the U.S. bond market, Miller remains optimistic on the strength of the U.S. economy.
“There’s no obvious imbalance” that could point to a coming recession, said Miller.