The year-and-a-half bull run in emerging markets will end at some point, and Pacific Investment Management Co has some advice on where investors should be positioned when that happens.
The world's second-biggest bond manager is advising clients to seek out the "Australian Dream", shorthand for countries with strong institutions where external imbalances are low and inflation expectations are under check.
In places that meet the criteria - like India, Indonesia and Poland - a weaker currency won't translate into a rout in local notes.
The idea is that in times of weakness, investors should avoid countries such as Turkey, Colombia and Brazil, which are seen as particularly vulnerable to a stronger dollar, higher US interest rates and any ramping up of global trade protectionism.
Susceptible countries used to be known as the "Fragile Five", but they're decreasing in number as emerging economies begin to resemble more developed ones, according to Gene Frieda, a London-based global strategist at Pimco, which oversees about $US1.5 trillion of assets.
"There's a much larger contingent of emerging-market economies living the Australian Dream today," he said.
"Their currencies have the capacity to weaken without blowing up the bond markets."
While Pimco still considers emerging markets the "cheapest asset class" for now - benefiting non-Australian Dream assets such as Brazilian local notes - Frieda said distinguishing among developing nations would be more important as the rally loses its legs.
When Harvard economist Ricardo Hausmann first described the concept of the Australian Dream at a conference in 1999, emerging economies were mired in crisis.
His vision was a world where currency shocks in developing countries didn't send bond investors rushing to the exits. Australia, while it was firmly in the developed-nation category, served as a model, with a semi-volatile currency but more stable bonds.
While the use of that term didn't really catch on in the subsequent decade, Goldman Sachs Group revived it in a 2014 note to clients.
There's a much larger contingent of emerging-market economies living the Australian Dream today.
Typically, Australian Dream nations possessed predictable governments and central banks, improving external balance sheets and a greater ability to withstand trade shocks, said Andrew Keirle, who oversees more than $US1 billion for T. Rowe Price's fixed-income division.
That was seen in last year's fourth quarter as currencies in Hungary, Romania and Poland weakened between 6.8 per cent and 8.7 per cent against the US dollar, while their benchmark local bonds dropped much less.
With foreign investors underweight emerging-market local notes, the increasing percentage of bonds held by domestic buyers also acts as a buffer during selloffs, according to Jan Dehn, the head of research at London-based Ashmore Group, which oversees about $US52 billion of assets.
That occurred from the eve of the taper tantrum in May 2013 through December 2015, when developing-nation currencies depreciated by about 14 per cent, while average local bond losses were 7.3 per cent, according to data compiled by Bloomberg.
"If that did not blow up their bond markets, nothing will," Dehn said.
Bloomberg