Capital Ideas^TM

Using cluster analysis and regression techniques, this paper highlights the importance of active management and bottom-up fundamental research in effectively navigating the multifaceted emerging market debt (EMD) landscape.

Key insights include:

Idiosyncrasies in EMD: Returns for both local and hard currency sovereign markets vary significantly across EM countries. What drives these differences? One might expect bonds from the same region or with similar credit ratings to move in sync, either in the same direction or with comparable magnitudes. While this can sometimes be true, there are numerous idiosyncrasies, which means this is often not the case.

Cluster analysis: The purpose of the analysis is to reveal the relationships between sovereign bond returns issued by different countries, which might not be immediately obvious when just looking at regional or rating splits.

In the local currency bond space, although the Latin American countries are generally clustered together, Chile is closer to Brazil than to Peru. Mexico, meanwhile, has a distinct return pattern compared to the other Latin American countries.

In the hard currency space, there appeared to be less differentiation. Combining the local and hard currency EM sovereign cluster analysis revealed that a country’s local currency sovereign bond returns do not necessarily move together with its hard currency sovereign bond returns.

Regression analysis: The paper identifies key return drivers for local and hard currency sovereign bonds. The analysis revealed that the factors driving returns differed not only between local and hard currency bonds but also varied significantly across different countries, highlighting the importance of tailored research and analysis.