(A correction was made to the company name in the first paragraph).

Keeping emerging market bonds as part of an investment strategy could still prove profitable, despite the fact they have experienced a sell-off this year, triggered by fears that issues in some countries could cause a wider contagion, according to a senior portfolio manager at asset management company State Street Global Advisors.

David Furey, a senior portfolio manager in the United States-based firm's Global Fixed Income division, said that although there had been a general weakness in emerging market investments, and "pockets of specific weakness" in countries such as Argentina and Turkey, whose currencies have witnessed dramatic falls in recent months (Argentina's peso has more than halved in value, while the Turkish Lira is down 38 percent), "we would say that emerging markets are in a lot better position than they have been fundamentally and that they have addressed some of their external vulnerabilities".

For instance, he said that many emerging market nations had addressed current account deficits and were not as reliant on foreign direct investment or portfolio flows into local equity markets.

He also said that while in the past high rates of emerging market inflation may have dissuaded many investors, this has eased.

"Over the last 10 years, emerging market inflation averaged around 4.75 percent, and today we're at 3.9 (percent)," Furey said. "While Inflation is obviously a feature of emerging markets, it's not a major issue like it has been in the past, and it's been on a downwards trajectory over the last five to six years."

Currencies undervalued

Rising interest rates and a stronger dollar in the United States have placed pressure on emerging market currencies, and on Sunday last week Furey said that an emerging markets local currency index run by JP Morgan was around 8.5 percent lower for the year to date. But he said that State Street's own models indicated that emerging markets currencies were already fairly valued earlier this year, and now appear to be undervalued.

He argued that although his firm had witnessed outflows from exchange-traded funds focused on emerging market assets earlier this year, "recently we have seen inflows".

"We also manage a lot of institutional assets in this space and we have seen very recently some rebalancing back into emerging markets."

A number of Gulf countries, including Bahrain, Saudi Arabia, Qatar and the United Arab Emirates, have recently been earmarked for inclusion into three emerging bond market indices run by JP Morgan, starting from January next year, which is a sign of their increasing importance as sovereign issuers to debt capital markets. The bonds will be included in the index in phases between January 31 and September 30 next year, according to Reuters.

Abhishek Kumar, lead emerging markets manager for State Street Global Advisors, said that in terms of sovereign debt issuance "GCC [Gulf Cooperation Council] countries have already been punching above their weight" this year.

"Out of total issuance of about $159 billion from countries in JPM’s EMBI (emerging market bond index) excluding China, GCC issuers have issued almost $58 billion of debt; more than 36 percent of all EM debt issuance this year," Kumar said in a statement emailed to Zawya at the end of last month.

He said that GCC government debt issuers currently have to pay a premium to issue, and suffer wider credit spreads (above benchmarks) than bonds that are currently included in the index.

"From the end of June, that is before the index inclusion announcement to now, Chilean 10 year USD denominated bond has tightened by almost 20 bps (basis points) while similar maturity Saudi debt is only tighter by about 10 bps.

"The supply demand mismatch which had existed is likely to be reduced with the index inclusion and should give a boost to performance of GCC bonds,” Kumar argued. In August, UBS analyst Michael Bolliger said the inclusion of GCC bonds into an index could lead to around $45 billion being invested into GCC bonds if they were to gain a 12 percent weighting of the JP Morgan Emerging Bond Indices, although this figure would include investments that will already have been made by some active managers ahead of inclusion.

Short-term pain?

Yet the prospects for emerging market, at least in the short-term, looked to be worsening as last week drew to a close. On Thursday, positive economic data in the United States led to bond yields rising and a sell-off both in short-dated and long-dated U.S treasuries (as bond prices usually move in the opposite direction to yields) and also triggered a sell-off in U.S equities markets.

Hussein Syed, chief markets strategist with foreign exchange trading platform FXTM, said in a note on the markets sent to media on Thursday that "with (equity) valuations still elevated compared to historic levels, it requires an upbeat earnings season for stocks to maintain their bullish momentum, but the risks are growing with borrowing cost on the rise and fixed income markets looking very attractive".

London-based Capital Economics also said that higher interest rates made emerging markets less appealing.

"Despite a rebound in recent weeks, the outlook for emerging market assets is still poor," the firm argued in a note published on Thursday. "The backdrop of slowing global growth, rising U.S. interest rates and protectionist rhetoric will dampen demand for risky assets globally. We think that EM equities will fall further, bond yields will continue to climb as credit spreads widen, and EM currencies will generally depreciate," it said.

(Reporting by Michael Fahy; Editing by Shane McGinley)


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