Hard currency (HC) and local currency (LC) emerging market debt (EMD) have already delivered 13% and 10.3% this year respectively.
But will we get compensated for rising emerging market political and macroeconomic risks?
The external outlook for EMD is supported by plentiful global liquidity and declining core rates.
The majority of emerging market central banks have joined their developed market (DM) counterparts on the monetary policy easing path.
The International Monetary Fund downgraded global growth to 3% for 2019, expecting only a marginal recovery to 3.4% in 2020.
While the US may not enter a recession in 2020, the economy is likely to continue slowing down.
Even if the US and China reach a trade deal and no new tariffs are introduced until the next US presidential election, headline risks around trade are likely to persist.
This backdrop of monetary easing is likely to limit risks to global growth in 2020. There may even be upside potential if trade tensions subside more decisively.
This suggests a decent performance of riskier fixed income asset segments.
Absolute EMD HC and LC valuations at 5% are not attractive in absolute terms but remain attractive relative to DM credit, especially in the high-yield space.
Since August, the spread to US Treasuries of high yield (HY) versus investment grade within EMD HC has reached 2008 highs, reflecting material Argentine and Venezuelan corrections that month.
Yet, the spreads over US Treasuries of HY commodity exporters in Sub-Saharan Africa or reform-oriented idiosyncratic countries, also widened since late July.
Trade de-escalation is likely to help recovery in the relative value of HY versus investment grade-rated countries within EMD, which also confirms a cautiously optimistic stance on the asset class.
Last but not least, inflows into EMD and other DM spread asset classes are likely to persist.
Diversification, reasonably clean positioning, and higher expected returns relative to defensive core rates and aggressive equity alternatives will further strengthen the allocation arguments in favour of EMD.
Diliana Deltcheva is head of emerging market debt at Candriam
• Decisive China-US trade tension stabilisation in Q4 extending until the 2020 US presidential election
• Stable or lower core rates around current levels
• Trade escalation with extended headline risks around further tariff implementation or transition into currency wars
• More significant than expected Chinese slowdown weighing further on EM growth