going native with emerging-market local-currency bonds

Going native with emerging-market local-currency bonds 1/10

Asset Management

July 2012 WHITE PAPER

Going native with emerging-market local-currency bonds

Executive Summary

Over the past two decades, emerging markets (EM) have advanced up the ladder of global economic prominence. Their strong growth in the aftermath of the global economic crisis has accelerated that trend. The important difference is that most emerging markets survived the 2008 credit crisis much better than their developed peers and came out of it with strong eco-nomic growth. Better balance sheets coupled with less indebtedness compared to developed countries in the wake of the crisis have lowered the risk of investing in the region and have prompted further credit-rating upgrades. While developed economies are suffering from dele-veraging as consumers continue to cut spending in favor of building savings and slashing debt, the fundamentals of emerging markets remain robust.

The success of the emerging markets in terms of their economic growth is undeniable, and a growing investor base is seeking to take advantage of that. EM equities in particular and, to a lesser extent, EM bonds issued in hard currencies have gained a much higher profile over the last decade and are used to align tactical and strategic asset allocations in many portfolios. More recently, the trend has shifted toward incorporating EM bonds denominated in local cur-rencies, but still mostly for tactical positioning.

Although it may be convenient to lump emerging-market assets together into a single broad category, this category is far from homogeneous. The three asset classes mentioned above in the EM sector each have their own strengths. While specific allocations naturally depend on each investor’s preferences and constraints, we think that EM bonds – especially those issued in local currencies – are still underrepresented in most long-term allocation concepts even though they appear to offer an attractive risk-adjusted return.

In this paper we examine how the local EM bond market has developed and analyze the key characteristics of this sub-asset class. In our view, there have been three decisive developments in the emerging-market local-currency bond segment that can be summarized by the keywords:

ȩ “strength”, ȩ “size”, ȩ and “performance”, with currencies as an additional driver.

We also lay out the case as to why we believe that EM local-currency bonds are attractive in a portfolio context since they potentially may:

a. provide significant diversification due to their relatively low correlation with traditional core-market bonds and other assets such as equities, and

b. offer attractive risk/return characteristics suitable for investors seeking to enhance their performance in a low-interest-rate environment.

Adrian Zürcher

Senior Investment Strategist

CIO Office

Florence Lombardo

Investment Strategist

CIO Office

2/10 Going native with emerging-market local-currency bonds

Strength: Fundamental data as decisive factor

A historic shift has been underway in the world economy as many emerging-market economies are experiencing a sus-tained period of rapid growth. Demographics, rich natural resource endowments, low labor costs, high productivity growth, contained debt-to-GDP ratios and the need for improved infrastructures are primary engines that have pro-pelled their persistent climb upward in the global ranking of economies by size as measured by USD-denominated GDP (Table 1). The years 2009 through 2011 proved to be a water-shed period in this context. China surpassed Japan to become the world’s second-largest economy. Brazil overtook Italy and the UK to become the sixth-largest economy. Russia joined the list of the Top 10 economies, moving past Spain to rank ninth, and is expected to continue to ascend. India, which currently ranks eleventh, is expected to rank ninth by 2017. By then, all

Table 1: Ten largest national economies in terms of GDP (nominal, USD)

2009 2011 2017ERank Country Nominal GDP

(USD bn)Country Nominal GDP

(USD bn)Country Nominal GDP

(USD bn)

1 United States 13938.93 United States 15094.03 United States 19704.59

2 Japan 5035.14 China 7298.15 China 12713.86

3 China 4990.53 Japan 5869.47 Japan 6695.69

4 Germany 3307.20 Germany 3577.03 Germany 3893.04

5 France 2631.92 France 2776.32 Brazil 3267.90

6 United Kingdom 2180.65 Brazil 2492.91 France 3198.00

7 Italy 2116.63 United Kingdom 2417.57 United Kingdom 3167.53

8 Brazil 1622.31 Italy 2198.73 Russia 3105.81

9 Spain 1459.42 Russia 1850.40 India 2906.49

10 Canada 1337.58 Canada 1736.87 Italy 2248.40

ȩ Emerging Markets

Source: IMF, Credit SuisseNote: Data for 2017 are IMF estimates

four BRIC (Brazil, Russia, India and China) countries are likely to rank among the Top 10 economies in terms of size. We are convinced that this is not just a cyclical shift, but rather a pow-erful structural trend. After having been plagued by some pain-ful defaults in the 1990s, emerging-market countries did their homework over the last decade and have significantly cleaned up their act. Many emerging-market countries have imple-mented sound fiscal and monetary policies. This has resulted in a structural improvement in creditworthiness and has served to considerably reduce the historically high volatility of emerg-ing-market asset values. Sovereign debt has been systemati-cally reduced, and the debt ratios of most EM countries are now well below the European guidelines outlined in the Maastricht Treaty (Fig. 1). A relatively low level of debt is an important factor for a country’s creditworthiness. Over the last

Figure 1: Evolution of sovereign debt

Source: IMF, Credit SuisseNote: Data for 2016 are IMF estimates

0

10

20

30

40

50

60

70

80

90

100

1995 2000 2010 2016E

Government gross debt as percentage of GDP

Maastricht Treaty Guideline


Source: Bloomberg, Credit SuisseLast data point: April 1, 2012

Table 2: EM credit ratings

S&P Credit Rating long-term EM-BondsForeign Currency Local Currency

Jan 02 Apr 12 Jan 02 Apr 12

Brazil BB- BBB BB+ A-

Chile A- A+ AA AA

Colombia BB BBB- BBB BBB+

Mexico BB+ BBB BBB+ A-

Peru BB- BBB BB+ BBB+

Czech Republic A- AA- AA- AA

Hungary A- BB+ A+ BB+

Poland BBB+ A- A+ A

Russia B+ BBB B+ BBB+

Turkey B- BB B- BBB-

Egypt BBB- B #N/A N/A B

South Africa BBB- BBB+ A- A

China BBB AA- BBB AA-

India BB BBB- BBB- BBB-

Indonesia CCC BB+ B BB+

Malaysia BBB A- A A

Philippines BB+ BB BBB+ BB+

South Korea BBB+ A A A+

Thailand BBB- BBB+ A- A-

Investment grade

few years, rating agencies have repeatedly upgraded the credit ratings for many emerging-market countries. A large majority of those countries (more than 80% of EM local-cur-rency bonds in the main benchmark) have achieved invest-ment-grade status with a continued positive outlook (Table 2). This development enables emerging-market countries to take on a growing proportion of their new debt in local currencies rather than having to accumulate it in foreign currencies (Fig. 2). This is an important trend because it reduces the inconsistencies between income in domestic currencies and debt settlement in foreign currencies. Other key credit risk parameters such as current-account structures and foreign currency reserves have also improved markedly over the last ten years. Furthermore, there have been major improvements at the political level such as the independence of domestic central banks and the adoption of inflation targets, which have led to better control of inflation while at the same time strengthening the credibility of monetary policy. All of these factors nowadays enable emerging-market countries to pursue significantly more flexible fiscal and monetary policies than their Western counterparts.

Figure 2: BRIC external and domestic debt

Source: BIS, Credit SuisseLast data point : December 31, 2011

0

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600

800

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1,200

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1,600

1,800

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

USD bn Brazil

External Debt Domestic Debt

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1,200

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

USD bn India

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3,500

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

USD bn China

0

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180

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

USD bn Russia


Size: Still growing

Emerging-market economies presently account for around 53% of world GDP (Fig. 3) and generate approximately 75% of total world GDP growth weighted at purchasing power par-ity. In terms of their weight in the capital markets, emerging-market asset classes are still underrepresented. While EM stocks account for nearly 13% of the global equity market, EM domestic bonds make up less than 10% and EM external bonds roughly 2% of the respective global domestic and exter-nal fixed-income markets (Fig. 4). From this perspective, there is room for additional growth as local markets deepen and diversify, which improves liquidity. However, the liquidity in this asset class has already risen dramatically in recent years (Fig. 5). The increasing wealth of many EM countries has

Source: Datastream, Credit SuisseLast data point: December 31, 2010

Figure 3: EM share of world GDP

2010

Nominal GDP developed countries (46,7%) Asia (27,7%)

CEE & Russia (7,5%) Latin America (7,6%)

Middle East & Africa (4,5%) other EMs (6,0%)

USD bn18’194

USD bn5’292

USD bn5’178

USD bn3’032

USD bn3’690

USD bn34’889

Source: BIS, Credit SuisseLast data point: Q3 for domestic debt and end-2011 for external debt

Figure 4: EM share of total fixed-income market

Emerging Markets Domestic Debt

Emerging Markets External Debt

Developed Countries Domestic Debt

Developed Countries External Debt

9.8% 1.9%

62.5%

25.8%

EM Share of global debt outstanding (Total: US$ 96’749 bn)

Figure 5: Increased liquidity in EM bond markets

Source: Bloomberg, Credit SuisseLast data point: December 2011

0 0.2 0.4 0.6 0.8 1 1.2

China

Indonesia

Korea

Malaysia

Philippines

Thailand

Government Bonds Turnover

2005 2011

Figure 6: Size of EM debt market

Source: BIS, Credit SuisseLast data point: December 31, 2011

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

External Debt Domestic Debt

USDbn

accelerated the growth and development of an in-country insti-tutional investor base of pension funds, insurance companies, sovereign wealth funds and the like. Where there is demand, there is also supply, particularly since it is in the interest of emerging-market governments to eliminate areas of vulnerabil-ity in their economies. They are thus steadily paying off exter-nal debt and issuing new debt in local currencies. Another reason for EM governments to develop a local-currency sover-eign debt market is the need to sterilize large capital inflows. This environment has caused the local-currency bond market to surge in size, as figure 6 shows. Domestic bonds account for almost 85% of all EM bonds currently outstanding in the market. Meanwhile, liquidity, which has particularly been an


Figure 7: Size of regional EM local-currency debt markets

0

500

1,000

1,500

2,000

2,500

3,000

1994 1998 2002 2006 2010

EM Latin America

Total corp (USD bn)

Total govt (USD bn)

0100200300400500600700800900

1,000

1994 1998 2002 2006 2010

EM EMEA

Total corp (USD bn)

Total govt (USD bn)

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

1994 1998 2002 2006 2010

EM Asia

Total corp (USD bn)

Total govt (USD bn)

Source: BIS, Credit SuisseLast data point: December 31, 2012

issue for institutional investors, has improved and thus has substantially lowered the entry barrier. More domestic issues and more buyers feed a positive spiral and foster more growth. At the regional level, Asia by far is the largest market for local-currency bonds (nearly 65% of the overall market), but it is still a market that is not readily accessible to international investors due to restrictions on the movement of capital. Latin America,

the second-largest market, is extremely popular with many investors thanks to its relatively good entry opportunities, high liquidity, historically high yields and carry. The local-currency bond market in the EMEA (Europe, the Middle East and Africa) economic area is smaller by comparison, but can be accessed more easily by international investors (Fig. 7).

Performance: Above-average rewards

At first glance, the attractiveness of emerging-market bonds denominated in domestic currencies lies primarily in their higher expected returns on average. This asset class has sub-stantially outperformed global equities and other fixed-income investments in USD terms over the last ten years (Fig. 8, tab. 3). It has even outperformed the high-yield sector despite the much better credit rating. Of course, there is no free lunch and these higher returns come at a price. Investors in local-currency EM bonds have to contend with a wide range of risks: default risks, interest-rate risks, currency risks, liquidity risks and certain regulatory risks. In the past, emerging-market growth rates and inflation trends have been more volatile than in developed countries, and investors exposed to local interest risks have thus experienced higher levels of volatility. But over

the past decade investors have reaped above-average rewards for the risks taken on, as suggested by the Sharpe Ratio mea-sure, which is significantly higher than for traditional asset classes. Moreover, a growing pool of domestic capital provides an important source of support for EM local-currency bonds even during times of market stress and/or global risk aversion. During recent periods of market stress caused by problems in the G-10 bond segment, the home bias of a growing EM investor base has provided an important source of stability for foreign investors active in EM local-currency bond markets. EM domestic bonds have delivered an impressive performance over the last decade, and even though such levels of above-average returns might not be achieved in the future, we still think that the outlook for EM local-currency bonds remains

Figure 8: Overview of returns over the last ten years

Source: Bloomberg, Credit SuisseLast data point: June 12, 2012

Historical returns or financial market scenarios are not a guarantee for current or future performance.

0

50

100

150

200

250

300

350

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

JPMorgan GBI-EM Broad Index (local currency bonds, USD, Unhedged)MSCI World Index (USD, Daily, Net, TR)Citigroup WGBI All Maturities (Government bonds)BarCap Global High Yield Corporate (TR, USD, unhedged)

Table 3: Overview of returns over the last ten years


Return (annualized)

Volatility (annualized)

Sharpe Ratio

JPMorgan GBI-EM Broad 10.8% 7.4% 0.69

MSCI World 3.7% 18.4% -0.11

Citigroup WGBI All Maturities

4.2% 2.8% -0.51

BarCap Global High Yield Corporate

9.4% 11.5% 0.35


Figure 9: Volatility of returns


0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

1.6%

1.8%

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

1.6%

1.8%

2004 2005 2006 2007 2008 2009 2010 2011 2012

Standard deviation of daily returns over a centered 90-day moving window

GBI-EM Hedged (USD) EMBI+ (USD) GBI-EM Unhedged (USD)

sound. We believe that EM local-currency bonds will continue to deliver a solid performance and, as we describe later on in this paper, they also have very good diversification properties in a portfolio context. The low yield environment for many of the world’s developed economies in combination with very loose central banks adds to the attractiveness of EM local-currency bonds.

Emerging-market currencies as an additional driver of performance

Although adding currency exposure can be an effective means of enhancing portfolio diversification, it also adds volatility given the extent and frequency of fluctuations in currency values. EM local-currency bonds can be victims of capital flight, particu-larly during phases of extreme risk aversion when everything that smells of risk gets dumped regardless of valuation num-bers. The stress in international markets after the Lehman collapse severely tested these markets not differently from other risk assets. For local-currency EM bonds, severe cur-rency fluctuations were the main driver behind this extreme spike in volatility. An exchange-rate-hedged portfolio of EM local-currency bonds would therefore have been fairly stable during this time, as figure 9 shows. Investors could thus argue that it may be worth hedging the currency and to try to benefit only from the local yield curve.

From the standpoint of a tactical overlay strategy, this may make sense during severe risk-off periods. In our opinion, it would be unwise to implement hedges as a general strategy and across the board. Investors would give up some major benefits in terms of the return profile of EM local-currency bonds and their diversification potential in a portfolio, as we show later on.

In fact, in recent history it was very profitable to hold unhedged exposure in local currencies. Emerging-market currencies have appreciated noticeably against the hard currencies over the last ten years, and they still have upside potential going

forward, as indicated by the Credit Suisse fair value model (Fig. 10). The debt crisis still plaguing the industrialized nations has done nothing to stem this trend; on the contrary, it has even accelerated it. The majority of emerging economies, and above all China, have realized that a strategy based solely on export-oriented industrialization as a source of growth is no longer sustainable. This is prompting them to retrain their focus on domestic consumption, which harbors the risk of increased inflationary pressures. To combat price pressure, many central banks have let their nominal currency exchange rates appreciate. As a consequence, most EM countries have shifted away from policies that tied their local currencies to the USD and have moved to a float or quasi-float. Prior to the 1998 Asian currency crisis, more than 70% of developing countries pegged their currencies to the USD or ran fully dol-larized economies. Today, more than 80% of all EM countries allow their respective currencies to float with a certain degree of management. Going forward, we particularly expect Asian monetary authorities – given their undervalued currencies – to allow more nominal appreciation of their currencies to better control inflation.

Figure 10: EM currency valuations

Source : Credit Suisse Economic Research Last data point: July 5, 2012

-4

-3

-2

-1

0

1

2

3

Singapore

Colom

bia

Philippines

Egypt

Venezuela

Argentina

Czech R

ep.

Turkey

Brazil

Indonesia

Thailand

Israel

Hungary

Chile

Russia

S. A

rabia

S. A

frica

Peru

China

Ukraine

Hong K

ong

Korea

Mexico

Kazakhstan

Taiwan

Rom

ania

Malaysia

Poland

India

REER is more than one standard deviation stronger than the “fair value” REER

REER is within (+/-) one standard deviation of the “fair value” REER

REER is more than one standard deviation weaker than the “fair value” REER

REER: Real Effective Exchange Rate


Role within the portfolio context

It can be called a “black swan”, a coincidence, an exception or just bad luck; but whatever you name it, the last decade was a challenging time for multi-asset-class portfolio managers, and even more so for equity-only managers. Diversification still worked, but rather the other way around since low-risk assets have been the main source of returns. One challenge that investors have been facing is the increase in the correlation between risky assets. A lot of that is probably attributable to the increasingly globalized economy, which makes the quest for low-correlated assets extremely difficult. In this environ-ment, the question remains: How can an investor build a well-diversified portfolio that can withstand different market scenarios?

One sub-asset class that offers a fair amount of diversification is the domestic EM bond market. The performance of EM local-currency bonds not too surprisingly is uncorrelated with core government bonds (and more recently is even inversely correlated). Despite being risky assets, EM local-currency bonds are also uncorrelated with the high-yield corporate bond market and have a rather low correlation with other risky assets (Fig. 11).

By analyzing the yields on emerging-market bonds over the last ten years, we have discovered that globally important mar-ket factors (such as the development of US equities and Treasuries or global risk premiums) do not have a major influ-ence on EM local-currency bond returns, statistically speaking.

It is country-specific factors such as political risk, inflation and currency expectations that play a crucial role and have a sta-tistically significant impact on future returns. In contrast, the returns generated by most other high-risk asset classes like stocks, corporate bonds and even emerging-market equities are shaped chiefly by global financial-market conditions and global risk premiums.

To illustrate the drivers of EM bond returns, we have regressed weekly changes in several EM local-currency indices (JPMorgan GBI-EM Broad Diversified, USD, unhedged) against local market factors (CDS spreads, equity indices and expected changes in exchange rates over the next 12 months), global factors (US equities, US Treasury yields, US high-yield and investment-grade bonds) and global risk factors. Among a sample of eleven countries, the local-currency bond indices for a majority of the countries are statistically determined by all three local factors under consideration, while global market factors do not seem to have a statistically significant influence (Table 4). The most extreme case is Colombia, where only local factors seem to determine the change in the index.

We also included the dollar-denominated EM bond segment in our analysis (JPMorgan EMBI+). We found that hard-currency EM bonds are also influenced by local variables, mainly CDS spreads, albeit to a lesser extent. In fact, our analysis shows that dollar-dominated bonds, like other risky assets such as equities, react mainly to global market factors (Table 5).

Figure 11: Correlation between EM local-currency bonds and global/emerging asset classes


-1

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

2005 2006 2007 2008 2009 2010 2011 2012

36M rolling correlation to the JPMorgan GBI-EM Broad Index (local currency bonds, USD, Unhedged)

MSCI World (USD, Daily, TR, Net) JPM Emerging Markets Bond Index PlusCitigroup WGBI All Maturities (Government bonds) Index DJUBS Commodity IndexCS High Yield Index Value Morningstar Emerging Markets High Yield Index


Since investors’ fixed-income holdings usually have a heavy home-currency bias, we thought it worth taking a look at the diversification potential that EM bonds denominated in local currencies offer. As mentioned above, EM local-currency bonds correlate the least with their core-market counterparts. We have therefore plotted a simple straightforward efficient frontier for a pure CHF, USD and EUR (German bunds) gov-ernment bond portfolio and the GBI EM local bond index. This

analysis shows that by diversifying portfolios with emerging-market bonds, this not only can increase the expected returns, but can also reduce the expected volatility (Fig. 12). Indeed, all of the combinations of domestic and emerging-market bonds that are situated to the upper right of the mean-variance port-folio are considered efficient, meaning that these combinations maximize the return of the portfolio for a determined level of risk or minimize the volatility for an expected return level.

Table 4: Determinants of EM bond indices – local currency

Global Risk Premia Global Factors Local Variables

Fear/ Greed

US Investment Grade Bonds

US High-Yield Bonds

US Treasuries

US Equity CDS Equity

Expected Exchange Rate1 Intercept

No Obser- vations R-squared

Brazil 0.00 0.02 0.08 0.00 -0.12 0.00 0.39 0.00 0.00 524 0.72

(0.88) (0.38) (1.19) (0.74) (3.27)*** (5.00)*** (22.9)*** (0.67) (2.27)**

Colombia 0.00 -0.03 0.08 -0.01 -0.02 0.00 0.28 0.00 0.00 469 0.47

(0.35) (0.41) (0.86) (1.53) (0.49) (3.99)*** (12.7)*** (3.67)*** (1.69)*

Hungary 0.00 0.10 -0.21 -0.04 0.23 0.00 0.16 0.00 0.00 509 0.47

(0.12) (1.06) (1.84)* (5.06)*** (4.34)*** (10.0)*** (5.09)*** (6.66)*** (1.96)**

Indonesia 0.00 0.14 -0.10 -0.02 0.01 0.00 0.32 0.00 0.00 380 0.69

(1.70)* (2.01)** (1.04) (2.27)*** (0.21) (3.25)*** (15.1)*** (10.6)*** (1.89)*

Mexico 0.00 0.05 0.04 -0.01 0.03 0.00 0.18 0.00 0.00 524 0.58

(0.77) (1.27) (0.88) (2.28)** (0.88) (3.41)*** (8.51)*** (5.36)*** (0.11)

Peru 0.00 -0.01 0.21 -0.01 -0.03 0.00 0.10 0.00 0.00 276 0.46

(0.30) (0.26) (2.98)*** (2.24)** (0.75) (0.39) (4.91)*** (8.27)*** (2.03)**

Philippines 0.06 -62.01 66.76 11.17 -30.43 0.04 7.43 -4.06 2.02 511 0.00

(0.89) (0.32) (0.29) (0.66) (0.30) (0.47) (0.11) (0.56) (1.01)

Poland 0.00 0.06 -0.07 -0.03 -0.01 0.00 0.35 0.00 0.00 524 0.64

(1.03) (1.04) (0.92) (4.78)*** (0.32) (6.03)*** (19.0)*** (0.10) (1.81)*

Russia 0.00 -0.05 0.05 -0.01 0.07 0.00 0.15 0.00 0.00 363 0.38

(0.86) (0.80) (0.57) (2.04)** (1.90)* (3.00)*** (8.09)*** (5.28)*** (0.98)

South Africa 0.00 0.13 -0.05 -0.02 -0.10 0.00 0.41 0.00 0.00 524 0.70

(1.46)* (1.87)* (0.64) (3.37)*** (2.51)*** (1.46) (17.0)*** (15.3)*** (1.52)

Turkey 0.00 0.00 -0.04 -0.02 0.05 0.00 0.25 0.00 0.00 405 0.82

(0.13) (0.04) (0.60) (3.69)*** (1.44) (8.47)*** (16.9)*** (8.97)*** (2.74)***

t-statistics in parentheses. *p<0.05, **p<0.01, ***p<0.001 1 Over the next 12 months

Global Risk Premia Global Factors Local Variables

Fear/ Greed

US Investment Grade Bonds

US High-Yield Bonds

US Treasuries

US Equity CDS Equity

Expected Exchange Rate1 Intercept

No Obser- vations R-squared

Brazil 0.00 0.03 0.08 -0.02 -0.05 0.00 0.20 0.00 0.00 524 0.59

(0.11) (0.56) (1.08) (4.34)*** (1.41) (13.3)*** (11.2)*** (2.24)** (2.28)**

Colombia 0.00 0.09 0.09 -0.03 0.03 0.00 0.04 0.00 0.00 469 0.70

(0.32) (2.64)** (1.94)* (8.37)*** (1.42) (20.3)*** (3.49)*** (0.60) (2.98)***

Hungary 0.00 -0.07 0.07 -0.03 -0.07 0.00 -0.01 0.00 0.00 509 0.36

(1.26) (1.48) (1.15) (6.53)*** (2.43)** (13.1)*** (0.30) (1.83)* (2.07)**

Indonesia 0.00 0.15 0.30 -0.02 0.20 0.00 0.01 0.00 0.00 380 0.74

(1.04) (2.34)** (3.38)*** (2.65)*** (5.24)*** (11.0)*** (0.71) (4.96)*** (1.58)

Mexico 0.00 0.09 0.05 -0.03 -0.04 0.00 0.05 0.00 0.00 524 0.73

(0.85) (3.02)*** (1.32) (12.0)*** (1.75) (19.9)*** (3.25)*** (1.23) (3.91)***

Peru 0.00 -0.03 0.32 -0.02 -0.12 0.00 0.06 0.00 0.00 276 0.62

(0.32) (0.71) (5.15)*** (4.89)*** (3.37)*** (9.02)*** (3.63)*** (3.46)*** (1.71)*

Philippines 0.00 0.10 -0.06 -0.02 0.10 0.00 0.01 0.00 0.00 511 0.73

(1.26) (2.32)** (1.13) (5.31)*** (4.59)*** (26.7)*** (0.70) (1.16) (4.16)***

Poland 0.00 -0.07 0.11 -0.04 0.02 0.00 -0.01 0.00 0.00 524 0.39

(0.21) (2.36)** (3.07)*** (15.8)*** (0.99) (4.08)*** (0.73) (1.35) (3.02)***

Russia 0.00 -0.03 0.25 -0.02 0.03 0.00 0.01 0.00 0.00 363 0.83

(0.73) (0.87) (6.36)*** (8.50)*** (1.73) (21.0)*** (0.59) (1.47) (2.93)***

South Africa 0.00 0.07 0.14 -0.03 -0.06 0.00 0.03 0.00 0.00 524 0.64

(2.26)** (2.45)** (4.11)*** (10.4)*** (3.41)*** (17.1)*** (2.46)** (3.44)*** (3.70)***

Turkey 0.00 0.03 0.08 -0.02 0.04 0.00 0.01 0.00 0.00 405 0.78

(0.73) (0.77) (1.59) (5.95)*** (1.56) (21.2)*** (0.71) (1.73)* (3.01)***

t-statistics in parentheses. *p<0.05, **p<0.01, ***p<0.001 1 Over the next 12 months

Source: Bloomberg, Credit SuisseLast data point : January 20, 2012

Table 5: Determinants of EM bond indices – USD

Source: Bloomberg, Credit SuisseLast data point: January 20, 2012


Source: Bloomberg, Credit SuisseLast data point: May 31, 2012

Figure 12a: Efficient frontier – United States

Annualized Return (in%)

Annualized Standard Deviation (in %)

Efficient Frontier using historical data over the period December 2002 – May 2012

Efficient Frontier US Government Bonds and Emerging Market Local Currency Bonds100% US Government Bonds100% Emerging Markets Local Currency BondsMean-Variance Portfolio4

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Mean-Variance Portfolio: 97% US Government Bonds

3% Emerging Market Local Currency Bonds


Figure 12b: Efficient frontier – Germany

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Mean-Variance Portfolio:88% German Government Bonds,




Efficient Frontier German Government Bonds and Emerging Market Local Currency Bonds (in EUR)100% German Government Bonds100% Emerging Markets Local Currency Bonds (in EUR)Mean-Variance Portfolio



Figure 12c: Efficient frontier – Switzerland

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Mean-Variance Portfolio:93% Swiss Government Bonds,





Efficient Frontier Swiss Government Bonds and Emerging Market Local Currency Bonds (in CHF)100% Swiss Government Bonds100% Emerging Markets Local Currency Bonds (in CHF)Mean-Variance Portfolio

Historical returns or financial market scenarios are not a guarantee for current or future performance.


Conclusion

In today’s markets, investors are faced with an extremely low interest yield environment and highly correlated markets. We believe that EM bonds have a unique profile ideal for helping to address this challenge, particularly when those bonds are issued in local currencies. While they have their own specific risks*, one of the major advantages offered by local-currency emerging-market bonds is their significantly higher interest

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yields compared to the core markets. They also offer addi-tional return potential if the national currencies appreciate and the currency exposure is unhedged. Generally speaking, the segment now exhibits lower volatility and better fundamentals than it used to. Moreover, its low correlation with traditional asset classes can enhance a portfolio’s overall risk /return profile.

* Risks of emerging-market local-currency bonds may be default risks, interest-rate risks, currency risks, liquidity risks and regulatory risks.

going native with emerging-market local-currency bonds

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