If ever there is an asset class that has come into its own in recent months, at least in theory, it’s emerging markets bonds. Emerging markets equities have suffered outflows, credit and other higher-alpha fixed income strategies are looking wobbly and yet investors of all shapes and sizes are looking to go defensive. What to do?
OK, a lot of absolute returns bond funds still offer the potential of a safe-ish haven, but they are forever being questioned for lack of transparency and a lingering doubt over the technology which enables them to invest in 30-40 strategies, numerous securities and derivatives all at the same time. Are they top down, bottom up, both or maybe even in between? Their marketing materials often have the smack of ‘trust in God’.
Emerging markets fixed income may not be everyone’s cup of tea but is at least a pure and understandable asset class, with a sufficient number of complex deviations from the index where active managers, and smart-beta managers too, can add value.
According to Luc D’hooge, Zurich-based executive director and head of emerging market bond funds for Vontobel Asset Management, emerging market debt (EMD) can be a stabilising factor in global investor strategies once again, as it was during the global financial crisis. “It was the first time, ever, that this happened,” he said on a recent trip to Australia. “EMD spreads don’t always come in during times of stress. After the GFC, EMD performed well. It was definitely a stabilising factor.”
Andreas Faeste, Sydney-based executive director of Vontobel, said that notwithstanding the attractive characteristics of the asset class in the current uncertain climate, investor demand had been “mixed”. “Some big funds are very much in favour in the long term. They may debate internally or with their consultants on how to access it, though – whether to have hard currency (US dollars or Euros) or local currency. Actually, a blend of them both is the most popular. Up until the trade ‘war’ local currencies had tended to outperform for a couple of years.
And then there are other investors who want to market time, picking when they enter the market. Faeste says that one thing is certain: if you have a lifestyle strategy or outcome-oriented strategy, such as for retirees, it will be very difficult to achieve your targets without emerging market debt in the mix.
D’hooge says that the expected higher return from EMD is largely due to the higher yield, however, active management through country and securities selection can add to this. “We sometimes see a gap in spreads to exploit.
He says that GDP growth numbers for emerging markets usually help investor sentiment in the asset class but this doesn’t necessarily mean good returns or valuations.
He had feared that the trade war between the US, China and some other countries – even neighbours Canada and Mexico and allies in Europe – would effect the emerging markets more than it has. “The loser in the end from all this will be the US,” he says.
“There’s definitely a risk in [EMD] but it’s not so bad. The corporates index will grow relative to sovereigns. They have shorter durations and sovereigns are not being issued much anymore.”
Vontobel has about US$2.85 billion in its EMD strategy. Its style tends towards value and event driven, with a high conviction approach and active currency management. The US dollar-denominated fund has been top decile against its Morningstar peer groups since inception at September 2015, with a 10.95 per cent return versus the benchmark return of 4.82 per cent.
D’Hooge admits, though, it is best to be benchmark unaware in EMD because the benchmark is “not created intelligently”. By its nature, cou8ntries which have to borrow more have more bonds on issue and therefore higher weightings in the index compared with countries which will be on a sounder economic footing.
– G.B.
