With the recent International Monetary Fund conference in Davos throwing in some startling statistics, for instance that almost 70 percent of global growth is coming from emerging markets, it’s time to look at how to play this oft volatile asset class.
Standard Life Aberdeen’s Emerging Market Debt Fund is a great example of gaining access to emerging market bonds without taking on huge amounts of risk. For instance, the government bonds in the portfolio are all hard currency, which may tone down their return potential but eliminates the FX risk local currency bonds contain.
Co-manager of the fund Kieran Curtis is no stranger to the asset class. Prior to joining Standard Life Investments, he was a portfolio manager and head of local currency bonds at Aviva Investors. Indeed, at his current firm he does run local currency bond portfolios so is a versatile and seasoned manager.
While most commentators view that it is the US that controls the fortunes of emerging markets with the relative strength of the almighty dollar, Mr Curtis sees another driver. He says the main source for how emerging markets are doing nowadays is China and also the regions have become their “own source of final demand” or in other words masters of their own destiny.
“Last year China was coming off the back of policy tightening. The loosening this year should stabilise things,” says Mr Curtis.
However, while China’s role in aiding emerging markets is clear, it’s a huge net importer of commodities for one thing, Mr Curtis is less of a fan of the country’s own fixed income offering. He says that there’s not a lot of government issuance and a lot of the corporate paper is state owned which gives it a ratings uplift (and a dampening of yields). He says that these sort of bonds “are the opposite of things we want to invest in”, which begs the questions what paper does take his fancy.
“We prefer to buy well run under leveraged private sector corporates which are under rated compared to global peers due to their balance sheets and domiciled in a country where the sovereign ceiling constrains the rating,” says Mr Curtis.
One example which the fund has a large holding of is Pemex, the Mexican state-owned petroleum company. Mr Curtis tends to favour those companies which are at least quasi state-owned as it essentially nullifies the default risk that is present in most corporate bond portfolios.
An eyebrow may be raised at the funds top holding, Argentinian state bonds as the country’s problems last year brought the spectre of the country’s historic debt default of 2001-2002 back to the fore.
However, Mr Curtis is confident that investors are getting adequately compensated for the risk they are taking on, and a 10% yield on US dollar terms is not a bad return. For those with a high risk appetite, Argentina’s local currency paper peaked at a 70 percent coupon but for this investors are taking on a lot of currency risk and with elections due to be held this year, political risk as well.
With a lot of global growth coming from emerging nations, this plays well to its credit markets. Fundeye recently reported that global growth contributions doesn’t necessarily translate to equity market performance. However, the same is not true for its bond markets.
Mr Curtis says: “We like growth. GDP was conceived as a way of seeing how much tax revenue can be made out of an economy and its construction is more beneficial for fixed income in riskier countries. We need to know that the revenues are growing to service the debt so you can see why it’s more important for fixed income investors than equity investors.”
The end of the commodities rout aided Lat Am countries specifically as Mr Curtis says the increase in prices for these goods will help countries with their balance of payments and refinancing of debt, some of which is due soon.
He also predicts that investment into Peruvian mining, one of the largest exporters of silver in the world, is going to grow by 28% this year, putting the country in a healthy position. Similarly Ecuador is going to invest in oil production which will give it much needed dollars to service its debt.
Navigating the world of emerging market debt, be it sovereign or corporate paper, is a hazardous space where it’s worth paying the basis points for actively managed expertise. As has been seen in the past, emerging markets go in and out of favour, although Mr Curtis says that institutional flows have been steady while retail money tends to be fast and experienced outflows during last year's market turbulence.
This fund should suit those looking to diversify their portfolio but with still relatively conservative risk appetites. Local currency bonds may have outperformed hard currency by some way in the last two years, similarly emerging market equities and currencies moreso but these asset classes are high risk and can depreciate rapidly. This is the middle way if you will.
Standard Life Investments Emerging Market Debt Fund A
Fund size $104m
Fee 1.66%
12 month yield 3.5 percent
3 year annualised return 3.4 percent
Top holdings, Argentinian bonds, Pemex bonds, Peruvian bonds
Net asset value growth
To read more about this fund click here
