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Fixed Income

Three Reasons for EM Short Duration Debt

September 2020 - 6 min read

Emerging markets debt has shown much resilience despite facing its share of pandemic-induced difficulties. A short-dated approach, in particular, can provide an opportunity to pick up incremental yield and diversification, with less volatility.

Emerging market asset classes have experienced somewhat of a rollercoaster ride thus far in 2020—weakening as the global pandemic took hold back in March and then rallying strongly in the subsequent months. With a still-uncertain economic environment, lingering risks on the horizon, and valuations that have snapped back from stressed levels, investors are rightly asking if opportunities in emerging markets (EM) debt still exist. The answer, we believe, is yes—but selectivity is critical. 

For investors looking to pick up incremental yield opportunities versus developed markets (DM) and gain exposure to the diversification on offer in EM—but who are more risk-averse, particularly against the current backdrop—EM corporate debt, and more specifically, short duration debt, could be part of the solution. In particular, we think there are three reasons short-dated EM bonds are worth consideration for investors.
 

1. Lower volatility

Short duration bonds tend to exhibit a lower volatility profile than other fixed income instruments. First, by definition, they have a shorter time remaining until maturity. Because of this, they experience less severe swings in pricing caused by changes in the economic backdrop or even the company’s earnings outlook. In fact, they often experience a gentle “pull to par” effect—meaning their prices tend to gravitate toward par as the maturity date approaches. 

Second, short-dated bonds have lower duration risk. This means the price of a short-dated bond is fundamentally less sensitive to changes in interest rates—compared to longer dated bonds—which enables investors to gain exposure to EM companies without necessarily being exposed to the dramatic ups and downs of interest rate expectations. 

And third, as short-dated bonds have less time to maturity (typically under three years in Barings’ short duration strategies, for instance), investors tend to have more visibility on the direction of a company’s earnings and liquidity position. As a result, short duration bonds are less exposed to deterioration in the underlying financial position of the corporate issuer, or even to detrimental or unexpected changes in the business plan. A company’s ability and willingness to meet their financial obligations is easier for investors to forecast over these shorter time periods. 

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