Emerging market bonds are approximately at fair value

17 Jun 2013 by Jim Fickett.

I pointed out in a recent post that EM bonds, which have taken a significant hit recently, might present a buying opportunity (Possible opportunity in EM bonds). After looking at yields and inflation in a little more detail, I think the fund I mentioned, PIMCO's Emerging Local Bond Fund, PELAX, is probably near fair value.

The top three countries targeted by the fund are Mexico, Brazil, and South Africa. Together, holdings from these three cover about half the value of the fund. In each of these countries bond yields are now at a level to give a positive and reasonable real return. For example, in Mexico inflation seems to have been under control for a decade or more, has averaged around 4% over the last couple years and in June was running at 4.6%. The ten-year government bond yield has so far in June averaged about 5.3%.

In South Africa the situation is quite similar to that in Mexico – inflation averaging around 6% and the 10-year yield currently around 7%. In Brazil the situation is a little more complicated. Official inflation figures are fairly steady around 6%, but an increasing number of price controls and other government subterfuges suggest inflation is, in reality, getting worse (Brazil inflation). On the other hand the current 10-year government bond yield is at about 10%, which does somewhat compensate for the danger.

Assuming these three countries are fairly representative (which, for PELAX, is probably the case), that suggests EM bonds are currently approximately fairly valued. If I didn't already have nearly my full allocation, I would buy more today. But since I already own most of what I want to own, I will save that one last purchase for a time when the assets are undervalued. I suspect such a time will come when Japan gets into deeper trouble or people finally realize Draghi is not really in a position to do “whatever it takes” for Europe.