While valuations in emerging bond markets may look fairer after solid performance in 2019, we believe various factors remain supportive to the outlook.
These include the prevailing low interest rate environment in developed markets, which underlines the appeal of higher yields from emerging market debt in hard and local currencies.
In many cases, emerging economies offer positive real yields, which furthermore compares favourably against the backdrop in developed markets.
We would also note that other relevant asset classes, such as US high yield debt and equities, performed strongly in the past year, helping to maintain the relative attraction of holding exposure to emerging market bonds.
In assessing opportunities, we believe that low default rates contribute to the investment case for emerging market debt, together with the tone of global monetary policy.
While global economic growth data will need to be monitored closely, current forecasts remain reasonable, if not spectacular.
Key risks continue to include idiosyncratic country stories, such as in Lebanon and Argentina in the past year, as well as geopolitical themes.
Within the latter, tensions in the Middle East, with related volatility in the oil industry, could remain a focal point.
Despite Argentina's recent turmoil, we increased exposure to the country towards the end of 2019.
We felt its debt restructuring outlook showed improvement, assisted by the new government's appointment of Martin Guzman, a debt restructuring expert from Columbia Business School, as its economy minister.
We bought hard currency sovereigns in several segments of the curve, which took our stance from around neutral to a small overweight exposure.
Our overall preference for a flexible emerging markets bond strategy remains to hold broadly neutral allocations across the hard and local currency sub-asset classes.
For local currencies, we maintain positions on a selective basis, with diversity across regions via moderate exposures that include the Russian ruble, Brazilian real, Indonesian rupiah, Chilean peso, Polish zloty, Malaysian ringgit, and Mexican peso.
In our view, few emerging market central banks are likely to continue cutting interest rates in 2020.
We believe this raises the prospect that currencies, rather than rates, may be a key driver of returns in the year ahead.
Claudia Calich is head of emerging market debt at M&G Investments
• Elevated real yields relative to developed markets
• Low default rates
• Geopolitical risk
• Idiosyncratic country risk, for example Lebanon and Turkey