Emerging Markets vs Trump 2.0: M&G (Lux) Emerging Markets Bond Fund

^{Source: M&G, Bloomberg, JP Morgan}

Figure 2: US Imports from Mexico and China; dynamics began to change in  President Trump’s first term

^{Source: M&G, US Census Bureau}

A review of 2024

Hard currency-denominated emerging market debt had a very good 2024, on the backdrop of a very difficult environment for fixed income in general. Hard currency government bonds finished the year up 6.5%, while hard currency corporate bonds fared even better, up 7.6% at the end of December, according to Bloomberg data.

Figure 3: Fund performance

Past performance is not a guide to future performance

Past performance is not a guide to future performance.

YTQ = year to most recent quarter end, 31 December 2024. *Benchmark: From 2 December 2013 the benchmark is a composite of 1/3 JPM EMBI Global Diversified; 1/3 JPM CEMBI Broad Diversified 1/3; JPM GBI-EM Global Diversified. The benchmark is a comparator against which the fund’s performance can be measured.

The composite index has been chosen as the fund’s benchmark as it best reflects the scope of the fund’s investment policy. The benchmark is used solely to measure the fund’s performance and does not constrain the fund’s portfolio construction. The fund is actively managed. The investment manager has complete freedom in choosing which investments to buy, hold and sell in the fund. The fund’s holdings may deviate significantly from the benchmark’s constituents. The benchmark is shown in the share class currency. Fund performance prior to 21 September 2018 is that of the equivalent UK-authorised OEIC, which merged into this fund on 7 December 2018. Tax rates and charges may differ.

Source: Morningstar, Inc., as at 31 December 2024, EUR Class A Acc, USD A Acc shares, price-to-price, net of fees, income reinvested.  Gross returns are product returns (priced at midday) from Morningstar, with the actual Ongoing Charge Figure reinvested back into the price, including income reinvested. Performance prior to 21 September 2018 is that of the M&G Emerging Markets Bond Fund (a UK-authorised OEIC), which merged into this fund on 7 December 2018. Since then, performance is shown for the M&G (Lux) Emerging Markets Bond Fund, a Luxembourg registered SICAV. Tax rates and charges may differ. Performance data does not take account of commissions and costs incurred on the issue and redemption of units.

The M&G (Lux) Emerging Markets Bond Fund is a flexible, ‘best-ideas’ fund whose managers have the freedom to invest in any emerging market debt security, be it sovereign or corporate, high quality or high yield, and in any emerging market currency. This flexibility, the active approach and our blended investment strategy have helped the fund deliver stable, consistent performance over the long term.

The fund aims to provide combined income and capital growth that is higher than that of the global emerging markets bond market (as measured by a composite index comprising 1/3 JPM EMBI Global Diversified Index, 1/3 JPM CEMBI Broad Diversified Index and 1/3 JPM GBI-EM Global Diversified Index), over any three-year period, while applying ESG criteria.

True to the fund’s blended investment strategy and based on an assessment of global, regional, and country-specific macroeconomic factors followed by in-depth analysis of individual bond issuers, the managers select the EM debt securities that they believe are likely to offer robust growth potential.

The recommended holding period of this fund is three years. In normal market conditions, the fund’s expected average leverage – how much it can increase its investment position by borrowing money or using derivatives – is 150% of its net asset value.

In 2024, we saw some parts of the market reverse their fortunes, with renewed geopolitical tensions and an environment that saw interest rates stay higher than what we may have expected at the turn of the year. Nonetheless, there were several positive stories, with the fund being well placed, in our view, to take advantage of certain themes: 

Credit selection and spreads

Credit selection, encompassing both country allocation and security selection, remains the predominant driver of relative performance for our strategy. In 2024, this contributed 176 basis points of outperformance versus the benchmark. Within hard currency sovereigns, our bias towards higher yielding issuers proved to be beneficial with the high yield portion of the market significantly outperforming investment grade (+13% and +0.32% respectively as at the end of 2024).

Looking at the hard currency index, nearly all countries delivered positive returns. This partly reflects the very broad-based compression of credit spreads we have seen within the asset class, with only a few countries, such as Venezuela, seeing spreads widen. While investment grade spreads have tightened to levels that remind us of those before the Global Financial Crisis, we believe the high yield segment continues to offer value in places, particularly in markets like Argentina, Ukraine and Tajikistan, where we maintained overweight positions throughout the year, delivering outperformance. Our exposure to Argentina was notably advantageous, with bonds rallying following Javier Milei’s presidential election victory and subsequent policy reforms.

Local currency bonds and EM currencies

In terms of strategy performance, emerging market currencies were the primary detractors, with 106 basis points of underperformance versus the benchmark. At the beginning of the year, we were overweight local currency bonds, anticipating that higher carry¹ countries, particularly those in Latin America, would provide some of the more robust returns.

However, by year-end it became evident that lower carry countries, predominantly in Asia where we have generally been underweight, outperformed. This dynamic was partly driven by idiosyncratic (country-specific) factors affecting the former and declining yields in the latter. We maintain a selectively above-benchmark position in local currency bonds. We foresee the potential for bond prices to rally if country-specific issues subside, and for there to be room for emerging market currencies to appreciate, especially as these now appear even more undervalued.

Duration exposure and inflation

Typically, we do not anticipate duration or yield curve positioning to be major drivers of returns except during periods of significant interest rate movements. This comes as a result of the strategy's generally tight duration exposure relative to the benchmark. Over the past year, duration contributed a marginal 0.2 basis points to relative performance. Throughout the year, we maintained an underweight position in USD duration while holding off-benchmark euro duration through bonds issued by countries such as Côte d'Ivoire and Benin.

Our underweight duration positions in China and Thailand were among the largest detractors, although an overweight in Brazilian sovereign bonds also weighed on performance. This was due to concerns over fiscal stability and rising inflation, which saw the central bank move to increase rates, bucking the trend seen within Latin America over the past couple of years. Overweights in Ukraine and South Africa sovereign bonds were both positive for relative performance, with the latter being somewhat of a standout performer off the back of expectations for reforms following the coalition government being formed earlier in the year.

A look ahead to 2025

The US dollar had a stellar 2024, exerting significant pressure on emerging market currencies. Throughout the first three quarters, the dollar's movement largely mirrored economic data, resulting in periods of both strength and weakness. However, the most notable shift occurred in the final quarter, driven by two key factors: Donald Trump's election victory and the increasing prominence of US exceptionalism – the US dollar’s dominance of global markets, which allows the US economy to function relatively well even with high fiscal and trade deficits and high fiscal spending.

Consequently, the US dollar concluded the year up 7.01%, as measured by the DXY index, which measures the US dollar against six other major currencies. Whether the US dollar will maintain its strength depends very much on Trump’s policies, but also on how the US Federal Reserve and the wider US economy react to these policies. In 2025, sentiment is likely to be influenced by uncertainties surrounding Trump's second term. The adage "history doesn’t repeat itself, but it often rhymes" is particularly relevant when considering the implications of these policies on emerging market fixed income. 

In 2025, we anticipate the continuation of several themes within emerging market debt, and believe we are well-positioned to navigate the threats and opportunities. 

Here are some of the strengths that we believe can be seen in emerging markets:

• Elevated Yields: Yields are very attractive within emerging markets, in our view, despite the extent of spread tightening we have seen during the year. Despite historically tight spreads, yields remain particularly elevated compared to other market segments. Looking at the yield of the sovereign hard currency debt index as a proxy for the broader asset class, we believe that we are not only provided with an attractive margin of error, but also a very compelling starting yield (see Figure 4).
  
  
• Controlled Inflation: The disinflation story is largely done (with a few exceptions in high-inflation countries such as Argentina, Turkey, Egypt and Nigeria), with EM central banks having managed to tighten monetary policy ahead of peers in developed countries. And, emerging markets continue to stay ahead of the curve despite recent pressures, with inflation largely under control.
  
  
• Growth Potential: Optimistic global growth forecasts, particularly when compared to developed markets, make the asset class look compelling, in our opinion. For example, the International Monetary Fund (IMF) projects growth in China to reach 4.6% this year and in India 6.5%. In advanced economies, the IMF sees economic growth at 2.7% in 2025 for the US, and at just 1.0% for the eurozone.²
  
  
• Default Cycle: Defaults within emerging markets are expected to remain low across both sovereign and corporate issuers, significantly below levels observed since 2020. According to research by JP Morgan, at the end of December 2024 the EM corporate high yield default rate was 3.5% compared with 8.7% in 2023. It is forecast to reach 2.7% at the end of this year³.

Figure 4: EM sovereign hard currency debt current yield vs. subsequent two-year returns

Past performance is not a guide to future performance

^{Source: M&G, 31 December 2024. JP Morgan EMBI returns from 31 December 1999.}

Figure 5: US and European high yield default cycles; the ratio of distressed issuers tends to lead default cycles

^{Source: M&G, JP Morgan, December 2024. The JPM EMBI Global Diversified Index is used as a proxy for EM sovereign hard currency debt.  A parallel shift in the yield curve is assumed. This is for illustrative purposes only and based on representative assumptions. This is not a projection or guarantee of future results. It is not possible to invest in an index.}

Current spread levels reflect some of these positive themes, with emerging market debt not standing out as an outlier relative to other parts of the fixed income market. However, in our opinion there is still plenty of value across various regions and countries, which are driven by individual stories. Fundamentally, we believe that we are very well placed to manage the asset class and that the investment philosophy underpinning our approach is perfectly aligned for navigating today’s landscape.

We advocate for an approach that emphasises patience, fundamentals, and diversification. Patience enables us to overlook short-term fluctuations and seize long-term opportunities, with our focus on fundamentals ensuring a disciplined approach to identifying attractive issuers thorough rigorous bottom-up analysis. Finally, diversification helps mitigate concentration risks, providing stability during periods of uncertainty.

Ultimately, this approach has proven its value over time, enabling us to adapt to changing environments, and to consistently deliver robust performance.

The views expressed in this document should not be taken as a recommendation, advice or forecast.

Other important information

For an explanation of technical terms, please refer to the glossary here.

Find out more about the M&G (Lux) Emerging Markets Bond Fund

¹Here, carry refers to the additional return offered by the higher interest rates and exchange rate differentials.
²SIMF World Economic Outlook Update, January 2025. 
²Default rates are par weighted and exclude 100% quasi sovereigns.