The recent swoon in values of many emerging market fixed income assets has brought out calls by some to avoid them altogether. In response, we remind investors that fixed income markets are diverse—and nowhere is this more apparent than in emerging markets (Exhibit 1).

Those who diversify among fixed income sectors often have to draw the line somewhere, but if they avoid all of emerging market fixed income, as some have recently suggested, they could be missing out on some compelling opportunities. We believe active managers can find value throughout the emerging market universe by judiciously diversifying their exposure to credit (sovereign or corporate bonds), interest rates (i.e., government bonds of different countries and maturity dates) and currencies.

emerging market debt spans geographics charts
Source: Bank of International Settlements, as of March 31, 2015.

Why emerging market fixed income offers a breadth of opportunity

When pundits opine on an asset class, they often make sweeping generalizations. For example, some have recently suggested that “emerging markets are at risk;” yet, in so doing, they overlook a number of opportunities for potentially attractive returns. Others have pointed to slowing growth in emerging markets; yet they are discounting the fact that some countries have shown continued economic resilience even amid a slowdown in such countries as China, Russia and Brazil (Exhibit 2).

emerging market countries have exhibited uneven economic growth chart
Source: Haver Analytics, as of June 30, 2015.
The mention of specific countries does not constitute a recommendation on behalf of the Fund or OppenheimerFunds, Inc. Past performance does not guarantee future results.

And even such “slowdowns” can vary. For instance, inflation often slows while growth momentum is slowing—but not always. While many emerging markets (such as China) currently have low inflation, there are some that buck that trend (Exhibit 3). Brazil is a case in point where consumer-price inflation is running at near double digits. We remain wary of Brazil’s credit quality given ongoing political struggles, but we think Brazil’s inflation will come down from lofty levels and may create an opportunity for investors to take advantage of double-digit interest rates in the future.

deflationg not an issue for emerging markets chart
Source: Haver Analytics, as of July 31, 2015.
The mention of specific countries does not constitute a recommendation on behalf of the Fund or OppenheimerFunds, Inc. Past performance does not guarantee future results.

Demographic differences between emerging markets are also significant. While some (such as South Korea and China) have among the oldest populations, others (e.g., South Africa and India) have among the youngest. All these countries offer diverse investment opportunities in fixed income—not only on the basis of short-term market and economic developments, but also on long-term trends driven by socioeconomic, political and demographic factors (Exhibit 4). We believe investors should incorporate these factors into their perspectives, rather than avoid emerging markets altogether and overlook the opportunities they present.

For instance, the currency of India—a country with a relatively young and well-educated populace, dynamic growth and a reform-minded government—has outperformed South Korea’s by more than 4% so far this year.1 In countries like India, monetary policy can have a greater impact on growth trends compared to peers. In contrast, in countries like Japan with aging populations, monetary policy generally needs to be more simulative, as negative population growth is a challenge to the economy. In this situation, interest rates are likely to remain low and monetary policy may have limited benefit. Though rates might not rise in a country like Japan, investing in fixed income assets that yield well below 1% is unappealing, regardless of how long monetary policy will remain accommodative.

u.s. demographically set to become next japan chart

Oppenheimer International Bond Fund investment strategy

By analyzing the global macroeconomic environment, as well as country-specific opportunities through bottom-up evaluation, investors can seek to take advantage of vast diversity in the international fixed income markets. Oppenheimer International Bond Fund diversifies investments across currencies, interest rates and credit while avoiding certain fixed income sectors that may be challenged in particular circumstances. In so doing, it stands to benefit from the potential for both diversification and local trends that may favor investment.

For example, in countries with relatively good fiscal positions (i.e., low or no budget deficits) but slowing growth and inflation, the Fund may invest in government bonds but hedge currency exposure. When sovereign credit conditions deteriorate because of high budget deficits or slowing tax revenue, the Fund may avoid government bonds and local currencies but invest in corporate debt of exporters that price their goods in a foreign currency.

Conversely, the Fund may invest in corporate bonds, maintain long exposure to a local currency and avoid government bonds if growth and inflation accelerate, a currency appreciates, credit spreads tighten and the interest rate rises.

Oppenheimer International Bond seeks to take advantage of these opportunities and more. Exhibit 5 highlights the diversity of emerging markets across 12 distinct opportunity sets. It shows how low correlations have been among four major emerging markets (i.e., Brazil, Russia, India and China, collectively known as BRIC) in three areas: foreign exchange, interest rates and credit. What’s surprising is the wide dispersion in how these opportunity sets behave relative to each other.

While BRIC assets exhibit strong positive correlations more than 20% of the time,2 they otherwise show mostly low or even negative correlations, which afford us relative-value and directional opportunities to seek to outperform the market. Those opportunities would be denied to anyone passing up on emerging market fixed income altogether.

emerging market assets for performance correlated chart
Sources: OppenheimerFunds, Bloomberg, Haver Analytics, JPMorgan Emerging Market Bond Index.
The mention of specific countries or currencies does not constitute a recommendation on behalf of the Fund or OppenheimerFunds, Inc. Past performance does not guarantee future results.