Despite considerable angst about low yield levels and talk of a “great rotation” from bonds to equities, fixed-income assets as a group have not performed badly thus far in 2013.

U.S. Treasuries, and by extension the Barclays Capital Aggregate Bond Index, have delivered slightly negative total returns (–0.6 percent in the case of Treasuries), with U.S. investment grade credit roughly flat and higher-yielding assets posting strong gains. U.S. high yield remains on a tear, with a 2.9 percent year-to-date return, and both European high yield and U.S. leveraged loans are up about 2 percent.

Against this backdrop, emerging markets debt, in particular the “sovereign” category (hard-currency denominated government debt), sticks out. The JPMorgan EMBI Global Diversified Index (EMBIG-Div) has dropped 2.1 percent year-to-date in total return terms, by far the worst performance among major fixed-income asset classes (Chart 1). While the U.S. Treasury sell-off explains part of the loss in emerging market debt, EMBIG-Div spreads have widened steadily in 2013, while yield spreads on investment grade debt have moved sideways and spreads on high-yield debt have continued to tighten (Chart 2).

Chart 1: Fixed-income returns, YTD (%)

Chart 1
Source: Bloomberg; data through March 20, 2013

Chart 2: Fixed-income asset class spread over U.S. Treasuries (bp)

Chart 2
Source: Bloomberg; data through March 20, 2013

There are several possible explanations for this poor absolute and relative performance, but none appears satisfactory:

Duration fears. Given the low level of Treasury yields and their rise thus far in 2013, investors might be looking to shed long-duration assets. But the EMBIG-Div, our proxy for the sovereigns, has almost exactly the same duration (a bit more than seven years) as the U.S. investment grade index, which has held up well in total return terms and has experienced modest spread tightening this year.

Generalized emerging markets worries. Perhaps investors have grown concerned about emerging markets in general, relative to U.S.-based assets. This notion seems somewhat appealing given that emerging market equities have also struggled in 2013. But emerging market corporate debt (labeled as CEMBI in Chart 1) has done well, posting a 0.9 percent return (year-to-date), with its investment grade and high-yield components tracking their U.S. counterparts closely. Emerging market creditworthiness concerns should affect corporate borrowers just as much as or more than their sovereign counterparts. Local-currency emerging market debt has also held up much better than hard-currency obligations, down 0.2 percent (year-to-date) despite yen depreciation, which has put pressure on several emerging market currencies and should represent a disproportionate negative for local-currency bonds.