In the first four months of the year, investors funnelled €22.8bn into emerging market debt funds with both local and hard currency funds being in strong demand. Net inflows topped €7.4bn in April, the highest number since July last year.
Investors have been attracted by the relatively high yields on offer in emerging markets, but EM corporate high-yield spreads have narrowed sharply over the past 16 months or so, reaching their lowest levels since 2011 (see graph) which should be a warning signal for investors. This is especially the case because EM debt sentiment, which is currently very bullish, can turn very rapidly.
“The signals of strong risk appetite highlight vulnerabilities, including growth disillusionment and any repricing of the Fed funds futures curve,” the Institute of International Finance warned last Friday.
Guillermo Osses, head of emerging market debt at MAN GLG, also recognises these concerns, pointing out that the current rally in emerging market debt has lasted for almost 18 months now. “This asset class is very volatile, and as a consequence the entry point matters,” he told Expert Investor recently.
Emerging market debt is not the only asset class profiting from the bullish sentiment that has gripped markets. In fact, all long/only asset class apart from US equities (which are seen as too expensive) and UK equities (which suffer from Brexit-related risk) and government bonds saw net inflows in April.
