Home Economy BlackRock: Beware EM Duration Risk in Era of US Reflation

BlackRock: Beware EM Duration Risk in Era of US Reflation

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                BlackRock: Beware EM Duration Risk in Era of US Reflation

The world’s biggest money manager says lengthening durations have put bond holdings at risk of big losses in the era of U.S. reflation. But dedicated emerging-market funds look unlikely to lose their taste for higher-yielding, if riskier, assets.

That’s why BlackRock Inc. recommends switching from index-tracking funds to active managers who can quickly shuffle the portfolios and shore up positions on developing-nation dollar debt threatened by inflation and higher rates. Bondholders face duration risk that means waiting an average 6.03 years to recoup investments, up from 5.66 years in January 2016. That’s a loss of 6 percent for every percentage-point increase in interest rates.

But two factors indicate investors will continue to accept a greater duration risk in emerging markets, according to Credit Agricole SA to Legal & General Investment Management Ltd. One, there’s increasing optimism that Federal Reserve monetary tightening will remain gradual, and two, emerging-market durations are still shorter than for U.S. corporate bonds.

“As long as the benchmark yields don’t increase massively, emerging-market investors will be prepared to go longer,” said Simon Quijano-Evans, a strategist at Legal & General in London. “It is very likely to continue because you have new heavyweight cross-over investors from developed markets.”

The duration, a measure of how long it takes cash flows from a bond to cover the price an investor paid, is rising in developing nations even as the pace of its increase in developed markets slows. Investors use the metric to gauge the sensitivity of their holdings to changes in interest rates.

U.S. pension funds, looking to cover their payment liabilities, are “moving along the yield curve” in search of higher yields, Quijano-Evans said. Emerging markets are an obvious place to get those returns, and investors won’t stop buying unless there’s a sustained yield pick-up in U.S. 10-year or 30-year Treasuries, he said.

A modest underperformance in Treasuries is unlikely to impel investors to wind up their yield-chasing trades, said Guillaume Tresca, a senior strategist at Credit Agricole in Paris. The Fed’s “shallow hiking cycle” is telling them it’s not yet time to cut durations.

BlackRock is touting its unconstrained funds, which have no restriction in terms of duration or diversification. Exchange-traded funds now carry longer durations, and being wedded to underlying indexes, have little ability to reduce them, according to the firm’s deputy chief investment officer of global fundamental fixed income, who spoke to journalists Tuesday.

“The bond math has become more prohibitive for fixed-income investors,” said London-based Scott Thiel, who runs $13 billion across 14 funds, including those that allocate between government and corporate debt. “It now takes longer to get the investment back and exposes you to interest-rate risk.”

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