(Bloomberg) -- Long relegated to the fringes of bond investing, emerging markets have just been thrust into the mainstream by JPMorgan Chase, in a clear repudiation of negative-yielding developed markets.
The investment bank has put local sovereign debt of developing nations at the heart of a new global bond index, accounting for 20% of allocations. Since similar gauges recommend about 2% weighting to emerging markets, wide adoption by global money managers and ETFs has the potential to set off a new wave of buying, according to Morningstar. A rally cut average yields on local-currency bonds by 50 basis points to 4.25% in the past year.
"If investors decide to use this benchmark this would clearly be supportive for emerging markets," said Anton Hauser, a money manager in Vienna who helps oversee $2 billion at Erste Asset Management and incorporates JPMorgan gauges into his modeling. "It's way higher than in traditional indexes."
From insurers and pension funds to sovereign wealth funds, investors have sought out local-currency debt of developing nations to replace income drained by sub-zero yields. At a time when investors have to pay to hold $11 trillion of the world's bonds, money managers are being forced to revamp investment strategies by venturing further afield to meet return targets.
Global investors that traditionally focused on developed countries boosted positions in emerging nations including in hard-currency assets to as much as 16% in June, from 14% a year earlier, according to a Morningstar survey of 96 U.S.-domiciled global funds. Pimco more than doubled holdings in its $14.9 billion global fund from March through July, to just over 10%.
"The biggest global fixed-income shops have been taking large off-benchmark positions and that has been quite difficult for allocators to model in those funds," said Mark Preskett, a portfolio manager at Morningstar Investment Management in London. "There isn't a globally recognized index out there where a fund manager can seek to outperform which has such a high weighing in emerging-market debt."
JPMorgan's index tracks $25 trillion of securities from 37 nations, with a weighted average yield of 1.35%, the firm said in a statement Monday.
While a fifth of the benchmark is devoted to emerging markets, another fifth carries negative yields. That will allow investors to assess local-currency notes of South Korea, Brazil and Mexico alongside bigger index members such as the U.S. and Japan, according to its developers.
"Emerging markets have become more mainstream," said Gloria Kim, head of the global index research group in New York. "Given the negative-yield environment, it will be important to look at emerging markets more closely as part of the strategic allocation."
The litmus test for the new benchmark will be whether ETFs adopt it and launch funds based on it, Preskett said. Investors hunting for yield have plowed a record $12.7 billion this year into ETFs that focus on emerging markets, according to BlackRock. That compares with a previous full-year record of $8.3 billion in 2012.
"Finally someone is actually recognizing emerging markets," said Jan Dehn, head of research at London-based Ashmore Group. "It's real progress."