June 2023 / INVESTMENT INSIGHTS
Inside the Engine Room of EM Local Currency Debt
A potentially rewarding asset class
Key Insights
- The volatility of emerging market local currency (EMLC) debt falls significantly with the holding period. This means that investment time horizon is key when investing in the asset class.
- The importance of coupon, price appreciation, and currency to total returns changes with the time horizon. Currency dominates the short run, while coupon dominates the longer term.
- The current attractive yield level of EMLC debt provides a good entry point for investors with over three-year investment horizons.
Emerging market local currency (EMLC)1 debt is a complex asset class that can behave quite differently over different time horizons. This can make it challenging for investors to analyze the opportunity that it offers. In this paper, we take a look at how investors might frame the opportunity more clearly, exploring alternative ways to think about the risk and return drivers of what is potentially a rewarding asset class.
EMLC debt is essentially a government bond investment, driven by currency and sovereign risk. It may be thought of as a higher-yielding, higher-risk extension of an investor’s global government bond allocation rather than being solely part of an EM allocation.
The starting point for any analysis is recognizing that the total return to investors in EMLC debt consists of three distinct drivers: coupon, price appreciation, and currency (FX). We’ll begin by looking at the impact of time horizon on EMLC debt investment outcomes and the role played by the different return drivers. We’ll then discuss some underlying dynamics of the three return drivers, seeking to draw investment implications for asset owners and asset managers along the way.
While elevated within short periods, the volatility of EMLC debt falls significantly as we extend the holding period. This means investment time horizon should be one of the first decisions to make when thinking about investing in EMLC debt.
The relative importance of the three underlying drivers—coupon, price appreciation, and currency—to total return changes dramatically depending on the time horizon: Currency is the largest driver in the short run, but coupon becomes the dominating factor over time. While investors cannot cleanly access the three components of EMLC debt returns separately, they can actively tilt their exposure toward or away from one or more return drivers.
Download the full article here: (PDF)
IMPORTANT INFORMATION
This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.
The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.
Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.
The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.
June 2023 / INVESTMENT INSIGHTS
Nathan Wang is a senior solutions analyst for the Multi-Asset Solutions team in the Multi-Asset Division. He is a vice president of T. Rowe Price Hong Kong Limited.
Wenting Shen is a solutions strategist and portfolio manager in the Multi-Asset Division. She is responsible for engaging clients and prospects in the Asia-Pacific region in consultative discussions to identify how T. Rowe Price can best meet their investment needs and objectives through the firm's broad equity, fixed income, and asset allocation investment capabilities. She is a vice president of T. Rowe Price Group, Inc., and T. Rowe Price Singapore Private Ltd.