Emerging market debt has recently become a more-widely accepted asset class for income investors looking to diversify their portfolio. It consist primarily of bonds issued by countries with emerging economies (Australia, Brazil, Taiwan, China to name a few) backed by taxes.
It was not long ago, however, that this asset class was basically off limits, frowned upon, or just impossible to access. And there wasn’t much demand, either, since this had been a volatile asset class. But as demand for this asset class has increased, so have the number of investment vehicles that can access it.
In the 1990’s and early 2000’s, many emerging economies experienced a significant fiscal crisis, similar to what the U.S., Europe, Japan and several other developed countries are experiencing today. These emerging economies have rebuilt their fiscal houses and are much further down the road to recovery than many developed countries.
With their fiscal issues “solved”, they are now reaping the benefits. Their credit rating is improving. Once, thought of as default prone, they are becoming much more stable. There are a few standout results, such as Russia which went from a C rating to BBB+ in about two decades. South Korea went from BB to AA- in the same time frame. And now, the average for all emerging market debt is almost BBB+.
Specifically, the issues they “solved” that resulted in higher credit rating can be summarized:
1) Emerging economies have reduced spending and are more fiscally prudent than before.
2) With spending limited, more funding can be directed to pay down debts which improves their balance sheets and debt ratios.
3) Long term issues have been addressed. The Social Security debate we are having in the U.S. was addressed years ago in emerging markets. Their solution: compulsory self-funded private retirement system. This clarity means it will be more likely for developing countries to pay down other debt.
4) A more stable local currency and better access for investors has opened them up to foreign investment.