How did the high yielding countries perform against the low yielders ?

In this blog entry, I will take a look at the performance of the emerging market domestic bond markets. Specifically, I want to find out if the countries with high government bond yields outperformed the countries with low government bond yields.


Since my last blog entry in July a lot of things have happened. By the end of October, Dilma Rousseff was reelected as president of Brazil and she is facing a serious problem. Brazil has a twin deficit - a government deficit and a current account deficit at the same time. On top of this, the national oil company - Petrobras - was put under investigation in a case of corruption and fraud in November.  Dilma chaired Petrobras from 2003 until she was elected as president back in 2010. But, if you already read my last blog entry about Brazil, you cannot be surprised to hear about corruption in Brazil.

I dont want to write about corruption in Brazil this time around. Rather, I would like to look at the "high yielding" countries in Emerging Markets and compare them to the "low yielding" countries.

So, which countries are "high yielding"? Brazil is a high yielding country with a 10 year government bond rate of around 12.5%. Another high yield country is Turkey with a 10 year government bond rate of around 8,10%. Naturally, we are talking about their local currency government bonds.

High yielding countries all have high yields on their local government bonds compared to low yielding countries, like Hungary, Poland and Mexico.

Which countries were performing in 2014?

Below, you can see the performance of 3 different portfolios - the benchmark, a portfolio of low yielding countries and a portfolio of high yielding countries. If you invested in a portfolio of government bonds from Brazil, Indonesia, South Africa, Turkey and Russia by the beginning of 2014 (equal weight of 20% on each country) - you would have underperformed the benchmark. An equally weighted portfolio of low yielding countries would have outperformed the benchmark.

The high yielders and carry

One of the reasons to invest in government bonds from emerging market countries is because of the carry. The carry is - in this context - the difference between the yield of the bond you invest in and the rate at which you fund your investment. You can read more about it in this blog entry. So,  if you want carry you would go for the high yielders, but these countries are also associated with the highest drawdown risk. What do I mean by that? Well, if the rate at which you fund your investment is beginning to increase - or maybe more importantly - if you expect the funding rate will increase in the near future, the carry trade will come under pressure and you would most likely close it out. That means that you have to sell the high yielding bond and this means that the bonds will drop in price if other investors do the same thing. If this happens a lot - if there is a lot of uncertainty about the course of monetary policy - you will see some underperformance of the high yielders versus the low yielders.

You might ask if you get the same results if you go a little further back in time. I looked at data from the beginning of 2013 until today. Below you find the same portfolios.

If you form an equally weighted portfolio of low yielders and compare the performance of this portfolio to the benchmark and to a portfolio of the high yielders from the beginning of 2013 the results are the same - as you can see above. The high yielders are the same in this sample; Brazil, Indonesia, South Africa, Turkey and Russia.

OK, but what about Russia ? What would happen to the portfolio of high yielders if I take away Russia - the one great problem of 2014. Well, this does not change the conclusions and the results for the sample 2013 - 2014, but does reverse the conclusion when you look at 2014 only.  

When we extended the period to include all of 2013 we obviously include the taper tantrum of May 2013 when Bernanke surpised the market and started to introduce tapering of quantitative easing.This introduced a lot of volatility and uncertainty about future monetary policy in the US. Also, this made the market question the logic behind the carry trade: If US rates were just about to rise, why invest in Brazil or South Africa, that brings you carry only if there is a nice difference between the US rate ?

Approaching 2015

We are approaching 2015 with less uncertainty about the future course of monetary policy than back in May 2013. Now, we are waiting for the FED to hike rates. We dont know when rates will be hiked, but at least we know that is the most likely next step.