In the ongoing search for yields in a low-yield environment, many have turned to emerging market bonds and related ETFs. However, investors may be in for rocky ride as political risk will be a major factor come next year.
Countries that make up over 50% of the Bloomberg Barclays developing-nation local bond index are set for a round of elections in the next 12 months, Bloomberg reports.
Investors interested in emerging market bond exposure have looked to a number of ETF options, such as the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB), PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY), VanEck Vectors Emerging Markets Aggregate Bond ETF (NYSEArca: EMAG), VanEck Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC), SPDR Bloomberg Barclays Emerging Markets Local Bond ETF (NYSEArca: EBND) and iShares Emerging Markets Local Currency Bond ETF (NYSEArca: LEMB). The potential political risks could cause problems for many passive, index-based bond ETF investors with emerging market exposure as many of the underlying benchmarks have similar country exposures.
Votes in countries like Russia are more predictable, but a tight race between heavyweight contenders like Brazil and Mexico could trigger rounds of greater political risk-induced volatility in the emerging markets, or shake up emerging market bond exposure that some fixed-income investors have taken this year in search of yield.
“Investors are definitely beginning to think about this stuff, but I suspect they aren’t prepared,” Kieran Curtis, a money manager at Aberdeen Standard Investments, told Bloomberg. “Brazil’s election isn’t until the end of the year, but it’s still somewhere that asset managers are holding quite a lot of risk.”
Among some of the biggest potential catalysts, South Africa will have a party leadership election in late December, Russia will have presidential elections in March, Colombia will have presidential elections in May, Indonesia will have local elections in June, Mexico has general elections in July, Malaysia has general elections in August, Brazil has general elections in October and Thailand has general elections in November.
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Citigroup recently detailed in a report that election risks over the next 18 months in 20 countries could play a crucial role in the timing of “things going wrong” in emerging markets.
For example, the financial crisis in Mexico in the ’70s, ’80s and ’90s all coincided with elections. Midterm elections in Argentina in 2001 was followed by the country’s default a few months later.
“It is certainly not the case that there is an ‘election curse’ or that every election is bound to create volatility,” the analysts including David Lubin told Bloomberg. “But there has, historically at least, been some loose connection between elections and crisis.”
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