Emerging Market Bonds: Expected Returns and Currency Impact

Abstract

Optimizing in local currency or in currency-adjusted expected returns depends on the portfolio base currency. Currency unhedged portfolios are more suitable for EUR-based investors and much less for CHF-based portfolios. The appreciation of the portfolio base currency represents a serious risk. Emerging market bond portfolios gain from the absence of currency risk when the portfolio base currency is the US dollar. The empirical results reveal that the traditional models like mean-variance-optimization (MVO), Minimum-Variance-Optimization (MinVo), and Sharpe ratio optimizations are suitable for portfolio allocation, using both local currency and currency-adjusted expected bond returns as inputs in the optimizations. However, network- and centrality-based allocations outperform traditional models.