(Bloomberg) — Local currency debt from emerging markets will provide the best returns for investors once the Federal Reserve begins lowering interest rates, according to Pacific Investment Management Co.
Domestic bonds have lagged their hard-currency peers this year as emerging-market policymakers held off on aggressive easing cycles in case US rates stayed higher for longer. Now, with the Fed set to cut borrowing costs next month, investors will be looking for alternative sources of returns from places other than US equities, money markets and private credit, said Pramol Dhawan, the head of emerging-market debt at the $1.9 trillion asset manager.
“We feel that local markets have the most value,” Dhawan said in an interview. “Where you’re earlier in the game and where the better value prospects are, is getting the EM central bank cutting cycles that will start opening up after the Fed starts going.”
The asset class has already begun picking up, with a Bloomberg gauge tracking emerging-market local currency debt delivering more than 2.3% returns in August, set for the best month this year. Performance has also closely tracked the gains in sovereign bonds this month.
Latin America has some pockets of value as high real rates are expected to fall, according to Dhawan, though he’s aware of the “trade off” with names like Mexico’s peso, which has underperformed most currencies this year, and is likely to be under more pressure if policymakers lower rates further.
Dhawan — whose Pimco’s $1.3-billion Emerging Markets Local Currency and Bond Fund, co-managed with Michael Davidson, has beat 98% of peers in the past year — also likes currencies and local bonds in countries like South Africa and Turkey. In both, central banks will likely deliver big cuts after they start the easing cycle later this year.
“When you’re in the virtuous cycle like those two countries are, then you can buy local bonds, you can not hedge the FX and you can get the effective double whammy,” Dhawan said.
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