Evolution of the Index
Over the past 10 years, the investable universe of emerging market government debt2 has changed profoundly, as measured by the J.P. Morgan EMBI Global. In fact, over this 10-year period, 32 additional countries / issuers have entered the index. Today, these 32 new countries now account for approximately 20% of the overall investable universe.3 Even more striking is the evolution of the largest issuers.
J.P. Morgan EMBI Global: Top 10 Issuers Then versus Now
As shown in the table above, 10 years ago, the investable universe was dominated by Brazil, Mexico and Russia. Today, the index has become much broader, but is comprised of emerging economies that have much shorter borrowing histories and lower credit ratings. In our view, although more countries are currently represented in the index, smaller, more questionable issuers have risen in prominence relative to larger economies. For example, Venezuela is now the third-largest issuer in the index. This ranks them just behind Russia, a drastically different economy and risk profile. Given the broadening of the index, returns and yields are increasingly being influenced by smaller issuers. For many investors seeking to increase exposure to emerging markets, they generally tend to think about the larger, more widely followed economies, as opposed to the smaller, less established countries. In its current form, the top 10 issuers now account for only approximately two-thirds of the weight of the index.
Determinants of Interest Rates
Bond yields seek to compensate investors in a variety of ways. In an effort to pinpoint the potential drivers of return, we thought it might be helpful to decompose a bond’s yield into its various components:
1) Nominal Interest Rates – Perhaps the largest contributor of yield, this portion of a bond’s return seeks to compensate investors for the time value of money; it’s essentially compensation for taking interest rate risk.
2) Credit Spread – The additional income in excess of nominal interest rates that lenders demand for the risk that they may not be paid back.
3) Transfer Risk – Technically, this could be a portion of the credit spread, but by identifying it separately, we are able to compare the emerging market “premium” to similarly positioned businesses headquartered in developed markets.
Relative Credit Spreads Between U.S. Corporates, EM Corporates, & EM Government Debt