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    GSAM Connect 
    |
    January 9, 2017

    GSAM Connect | January 9, 2017

    January 09, 2017 | GSAM Connect

    Emerging Market Debt and Rising US Rates: Lessons from History

    Emerging market debt can help diversify a portfolio and serve as a tool in the pursuit of yield and attractive risk-adjusted returns. The late 2016 selloff has raised a question for some investors: Do rising US interest rates represent a new negative factor for emerging market debt?

    We think the answer is no. While the possibility of nascent protectionism in the US and elsewhere is a risk we are watching closely, we believe fears of emerging market debt (EMD) sensitivity to US rates are overblown. Instead, we think this asset class’ fundamentals are more closely tied to global economic growth and individual country conditions – and that these larger forces may drive both duration moves and EMD performance.

    We base that view on the historical performance record, which has not shown much relationship between EMD and rising US interest rates. In fact, as Exhibit 1 shows, the J.P. Morgan EMBI Global Diversified Index, a broad index of US dollar-denominated EMD, has risen in each of 5 rising 10-Year Treasury yield periods since inception.

    EXHIBIT 1: EMD HISTORICAL RETURNS AMID RISING US INTEREST RATES

    Source: Bloomberg, JP Morgan, and GSAM. Analysis from October 31, 2001 – October 30, 2016. Chart shows EMD returns during rising rate periods, where US Treasury yields rose more than 75 basis points over the same period. GROWTH OF $100: A graphical measurement of a portfolio’s gross return that simulates the performance of an initial investment of $100 over the given time period. The example provided does not reflect the deduction of investment advisory fees and expenses which would reduce an investor’s return. Please be advised that since this example is calculated gross of fees and expenses the compounding effect of an investment manager’s fees are not taken into consideration and the deduction of such fees would have a significant impact on the returns the greater the time period and as such the value of the $100 if calculated on a net basis, would be significantly lower than shown in this example. Please see end disclosures for additional definitions. Past performance does not guarantee future results, which may vary. Diversification does not protect an investor from market risk and does not ensure a profit.

    By contrast, high-quality fixed income historically has often declined amid rising US rates. The Bloomberg Barclays Global Aggregate Bond Index, a broad basket of high-quality bonds, has shown relatively high sensitivity to US rates over time, which has not been true of EMD (Exhibit 2).

    EXHIBIT 2: Comparing Historical Rate Sensitivity in Global Bonds and EMD

    Source: Bloomberg, JP Morgan, and GSAM. Analysis from October 31, 2001 – October 31, 2016. Analysis shows the best fit line of the Bloomberg Barclays Global Aggregate Bond Index vs. US 10-Year Treasury Yields (UST yields) and the J.P. Morgan EMBI Global Diversified Index vs. UST yields. Strength of Relationship represents the R-squared value, which is a statistical measurement of how close a set of data fits a regression model. Past performance does not guarantee future results, which may vary.

    Investors in emerging market debt today in our view face a number of unknowns: The rise of protectionist sentiment in Europe and the US, a new US presidential administration, and the intricacies of individual emerging economies. What we do know is that worries around rising US rates do not have much basis in EMD’s historical performance record. For that reason, we think this asset class’ potential benefits for diversification as well as the search for yield and risk-adjusted returns are intact.

    Topics: Fixed Income, Emerging Growth Markets, Interest Rates, Inflation, Diversifiers

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    About the Author

    Brendan McCurdy

    Brendan McCurdy

    Vice President, Portfolio Strategy, Strategic Advisory Solutions, Goldman Sachs Asset Management

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