As the U.S. economy reopens from the Covid-19-induced recession and bond yields finally begin to rise again, the query is, how should investors restructure their fixed income portfolios to profit from the approaching economic recovery?
Most consider there isn’t a higher place for the U.S. to allocate its debt after the recession, but our evaluation shows that international and emerging markets are prone to profit most from rising U.S. consumer demand.
In fact, through the U.S. economic recovery, emerging market bonds – each corporate and government bonds – have outperformed U.S. bonds by over 8 percentage points per 12 months, way over during recessionary or “normal times.”
This is the results of our study of the monthly returns of all US dollar-denominated mutual funds across multiple asset classes since 1990.
Following the NBER’s classification of business cycles, we isolated 4 recessions over the past 30+ years: July 1990 to March 1991, March 2001 to November 2001, December 2007 to June 2009, and February 2020 to the current. We then analyzed how the typical fixed-income mutual fund in each group performed during those recessions, the 2 years after those recessions, and in “normal times.”
Whose debt is best?
| Emerging markets | Emerging market government bonds | International | International Sovereign | |
| Recovery within the USA | 18.78% | 15.45% | 11.54% | 14.47% |
| Normal times | 10.08% | 5.96% | 3.65% | 3.68% |
| US recession | 9.45% | 3.15% | 3.91% | 3.59% |
| Long-term within the USA | US middle school | US Short Term | US Ammunition | US firms | |
| Recovery within the USA | 10.74% | 10.46% | 6.19% | 10.50% | 11% |
| Normal times | 7.23% | 4.48% | 3.09% | 4.61% | 6.17% |
| US recession | 6.88% | 7.01% | 6.13% | 7.97% | 7.78% |
We have found that emerging market bonds perform higher in the primary two years following a U.S. recession than in some other period. The average emerging market bond fund outperformed U.S. recessions by 9.33 percentage points on an annualized basis (18.78% versus 9.45%) through the U.S. economic recovery.
Not only did emerging market bond funds perform best when the US economy recovered, additionally they outperformed all US-focused fixed income funds during such periods. This is true even for the riskier and most interest rate-sensitive funds. For example, the riskiest longer-dated US bond funds underperformed their emerging market counterparts by 8.04 percentage points on an annualized basis through the US economic expansion, namely 18.78% versus 10.74%.
This dynamic holds true for mutual funds specializing in emerging market government bonds. During recessions, these mutual funds delivered a mean annual return of three.15%. Of all of the bond types we examined—US bonds, international bonds, and emerging market bonds—this was the bottom average return during a recession.
However, during times of recovery within the United States, the identical mutual funds achieved a mean return of 15.45 percent per 12 months – greater than some other asset class during these expansion phases.
With the US economy finally starting to select up again after a difficult 2020, it seems logical to bet on US assets usually and US debt specifically. After all, why shouldn’t they profit from a domestic economic recovery?
But smart asset managers could have a special perspective and focus their fixed income investments broadly on emerging and international markets.
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Photo credit: ©Getty Images/ Jamie Grill
