Investors cannot ignore the wealth of investment opportunities offered by the emerging market debt (EMD) asset class. In a world of ultra-low or negative rates, investors have to look outside of developed markets in the ‘hunt for yield’. There is still around $16tn worth of negative yielding debt globally, and just 9% of global fixed income markets offer investors yields of over 3%1 – with unprecedented levels of coordinated monetary stimulus on a global scale, this is unlikely to change dramatically any time soon.

The EMD asset class not only offers huge diversification, encompassing around 100 countries at varying stages of their economic cycles, but it also provides access to high economic growth, with around 70% of global growth coming from emerging markets. With a growing investor base, EMD has been one of the fastest-growing fixed income sectors over the past decade, expanding into a widely diversified $23tn market, which is the same size as around 50% of all developed market government and corporate debt combined.

While the opportunities offered by EMD are evident, risk appetite towards emerging markets does still tend to swing dramatically, from periods of indiscriminate buying when sentiment is strong, irrespective of credit fundamentals, to selling ‘at any price’ when conditions are looking tough. But a more challenging macro backdrop doesn’t mean that investors should shy away from the asset class. Instead, an EM short duration bond approach can provide more cautious investors with exposure to the yield premium offered by EMD, while also limiting the impact of macro volatility.
The benefits of short duration
Carefully selected short duration emerging market bonds offer the benefit of attractive yields compared to developed market counterparts, but with lower volatility than broad duration bonds. This is because short duration bonds benefit from the ‘pull-to-par’ effect: as a bond gets closer to its maturity date, its price will begin to reflect only its credit default risk. If the bond doesn’t default, it will pay back its face value, irrespective or what happens to the US Treasury rate and other macro factors. This makes short duration bond strategies much less volatile than those with a broad duration.

In fact, the volatility of a 10-year bond is as much as 9x higher than that of a bond with a maturity of 3 years.2 By being invested in shorter duration bonds and holding them to maturity, investors can therefore “lock in” the yield-to-maturity while significantly reducing the volatility risk.

Exposure to EM short duration bonds can be beneficial across all market conditions, allowing investors to benefit from rallies when markets are more buoyant, while limiting downside risk in tougher times. Nevertheless, in order to achieve attractive risk-adjusted returns, we believe it is prudent to take an active, flexible investment approach, as accurate credit analysis is required to identify the names with the strongest fundamentals, which are trading at attractive valuations.

Short duration bond funds can be used as a ‘cash proxy’, as returns are highly likely to be positive with low volatility on a three-year rolling basis. As a significant portion of a short duration fund matures on a rolling three-year term, the high yield materialises into positive returns, independent of market conditions. Due to the high yield offered by emerging market debt, the realised return for EM short duration bonds is also likely to be much higher than developed markets bonds in US dollars.
Our approach at Jupiter
We launched the Jupiter Global Emerging Markets Short Duration Bond fund in September 2017, with an objective to provide attractive returns but with limited levels of volatility. We are pleased with how our investment approach has worked so far: since its launch, the fund has returned 13.8%, with the highest Sharpe ratio (return/volatility) in its peer group since inception.3

The last three years