Emerging Markets Sovereign Bonds

Investment Summary
Each month an investor ranks 10 Emerging Markets countries into 3 lists according to GDP, Debt to GDP and Inflation. The Investor buys and holds hard currency USD denominated sovereign bonds of the top 5 ranked countries.

Market Risk Indicators are used to identify country increased economic stress. When a Market Risk indicator indicates a country’s elevated risk, capital is not invested in the specific country but reallocated to the rest of the countries.

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Investment Performance (Good Investment Selection Guide)
Investment Return (?): 9.4% Volatility (?): 6.2% Sharpe Ratio: 1.51 Maximum Drawdown: -8.4%

Investment’s Fundamental Concept:
Value investing in emerging markets is profitable with high returns. Growth of emerging markets arises from Demographics growth, abundant natural resources, low labor costs and improving standard of living.

However, market risk indicators must be implemented to monitor and close investments early in these countries since they exhibit higher risks than developed markets.

Emerging markets dangers include political risks, economic inequality, unpredictable events like nationalization of industries and external debt defaults.

Value Investing in emerging markets includes analysis of fundamental and macroeconomic data. The most important macroeconomic indicators are country’s GDP Growth, inflation, debt levels, interest rates and balance of payments.

Investment’s Logic:

The Investment Universe of the strategy consists of currency 1-month forwards versus the US Dollar for the following countries: Brazil, Hungary, Indonesia, Malaysia, Mexico, Poland, Russia, South Africa, Thailand, Turkey

There are 2 type of debts issued by sovereigns of emerging markets: local currency denominated and hard currency denominated. Returns of local currency denominated debt are subject to additional currency risk for USD-based investors and are more volatile. Risk factors other than exchange rates that impact local currency denominated bonds are local interest rates. Legal risk is also important since local bonds are subject to local laws, whereas hard currency bonds are subject to international law.

The factors measuring country’s ability to service its debt are growth, debt to GDP ratio, inflation, reserve, current account, real exchange rates. These factors are important to predict emerging market bond’s return.

A ranking strategy will be implemented to determine which country’s bonds are worth investing in based on macroeconomic fundamental ranking first and then complete returns with forward-looking CDS spread filter.

A simplified ranking system uses three maroeconomic variables to determine ranking of a country’s ability to service its debt: GDP growth, debt to GDP and inflation.

Debt to GDP is important because before making a loan to someone you have to determine their ability to repay, and as important as their income is you also need to consider their outstanding debt.

Each month an investor ranks 10 Emerging Markets countries into 3 lists according to GDP, Debt to GDP and Inflation. The Investor buys and holds hard currency USD denominated sovereign bonds of the top 5 ranked countries if their CDS spread (Market Risk Indicator) has not deteriorated more than 20% over the past month.

When the CDS filter signals risk-off hte investor redistributes risk to the remaining countries. When the CDS filter signals risk-off for all countries portfolio’s capital is invested 100% into US money Markets.

Other Investment Strategy Characteristics:
Investment Type: Value Investing Investment Risk: 1/5 Very Low Backtest Range: 30-40 years Rebalancing period: Daily
Investment Strategy Markets:
  • Emerging Markets Sovereign Bonds