Standard Life Investments

Inside Global Insurance Investment

Emerging market debt – a credible answer in the quest for yield

In today’s environment of low yields and mounting regulatory complexities, emerging market debt offers an attractive option for insurers. Encouragingly, economic fundamentals in the region continue to improve, as reform initiatives undertaken by several emerging market governments start to bear fruit.

Emerging market (EM) debt has redefined itself over the years. No longer is it associated with questionable economic policies, volatile regimes and a lack of transparency. In fact, the once-stark differences between advanced and developing economies have become increasingly blurred. Today, it is developed markets – previously renowned for their stable governments, conservative monetary policy and lower debt levels – that are experimenting with unorthodox monetary policies in a bid to artificially control their economies.

By contrast, EM policymakers are sticking rigidly to the economic text book. The media often portrays Russia in a negative light, focusing on its use of ‘fake news’ or its role in the Syrian conflict. However, the Russian economy is doing well, for which the nation’s policymakers deserve credit. For instance, the decision to allow the ruble to depreciate earlier this year shows they are not afraid to take tough decisions.

Although EM nations are far from perfect, the political environment is looking more stable than in years gone by. In India, Prime Minister Narendra Modi continues to forge ahead with his ambitious reform agenda, fighting corruption and creating greater transparency around the workings of government. While pockets of uncertainty remain, the positives far outweigh the negatives. Argentina’s government is another of the key EM reformers. Led by President Macri, the economy has shown significant improvement after a period of subtrend growth. Mr Macri now has scope to accelerate the pace of marketfriendly economic and social reforms.

In China, many of the issues that concerned investors have failed to materialise. There has been no ‘hard landing’, nor have commodity prices collapsed. Rather, recent newsflow has been generally favourable, highlighting China’s efforts to address industrial overcapacity and defuse investment risk in the financial system. Meanwhile, rapid growth in household incomes has driven Chinese consumer sentiment to an all-time high, while China’s markets appear to have been reassured by the country’s 19th National Congress last month.

But is all this translating into positive performance? In short, yes. A weaker US dollar has acted as a tailwind for EM over recent quarters, driving strong investment flows and record bond sales in the region. Both hard and local currency EM debt has performed well this year, returning +8.45% and +10.34%, respectively. Looking ahead, EM growth prospects remain strong and real yields in local markets are attractive in a low-yielding world.

For insurers, EM debt holds significant appeal. The industry is faced with the ongoing yield drought and the difficult choice between the considerable governance demands of more complex debt instruments compared to a more familiar, much simpler bond investment. Standard Life Investments’ 2015 European insurance survey indicated EM markets would be an area where insurers expected to outsource more asset management. Indeed, we have observed a notable uptick in searches and interest in the asset class in recent months.

When considering an allocation to EM debt, it is vital for the insurer and the asset manager to maintain a strong and constructive dialogue. Placing an EM debt portfolio onto a balance sheet is no trivial consideration. However, a partnership-based approach to portfolio design that matches the insurer’s individual country, credit and currency risk requirements offers indisputable upside.