Strategic bond managers are starting to dip their toes back into emerging market debt, claiming investment in the asset class now could be a key driver of returns this year and beyond.
Emerging market bonds were sold off heavily in 2013, due to the proposed reduction in US quantitative easing and as emerging market economies began to struggle.
The headwinds for the economies are far from over, as the US continues to reduce its bond purchases, yet strategic bond managers are becoming much more positive on the asset class as other areas of fixed income look increasingly expensive.
The question of when to invest and how much to put into emerging markets looks set to be a key differentiator for how strategic bond funds perform in 2014 and for the next few years.
Aberdeen’s Rich Smith, who co-manages the Aberdeen World Strategic Bond fund, said “getting the timing right there will be the key thing for performance” for strategic bond funds this year.
Mr Smith said he has been “eagerly watching for opportunities within emerging markets” and has been “dipping a toe” into the asset class by buying into bonds with very low lifespans, meaning they offer less risk.
The Aberdeen fund already has a weighting in emerging market bonds, but it is mainly in Middle Eastern debt, which Mr Smith explained was looking even more expensive than before the May 2013 collapse in emerging debt.
So Mr Smith said that he was “looking to capitalise” on the rally in Middle Eastern bonds and “maybe rotate that into other areas of emerging markets”.
The main hard currency emerging market bond index, the JPM EMBI Global index, has sold off significantly since May 2013, when the US first suggested that it would start to reduce its government bond purchases.
The fall has been compounded by the strength of the pound against the dollar, meaning the index has lost nearly 20 per cent in sterling terms since May 2013.
But Aviva Investors’ Chris Higham is another strategic bond manager who has started to venture into emerging market debt, though he is also approaching it in a very cautious way.
Mr Higham said he has been “spending most of my time on emerging market debt at the moment”, having not been invested in it at all during 2013. He has been investing in a very “idiosyncratic” way into emerging markets, with only 2 per cent of the portfolio in the asset class so far but he is looking to raise it further, having reduced his high yield exposure from 40 per cent to 35 per cent.
He said: “Valuations have become a lot more attractive, with yields of approximately 6 per cent having been closer to 4 per cent before the sell-off last year. So while there is upside, it is very much on a case-by-case basis.”
David Roberts, who co-manages the Kames Strategic Bond fund with Philip Milburn, said emerging market debt “is worth watching for the first time in years”.
However, the fund only has a tiny 0.5 per cent exposure to the asset class because the managers have a strict risk tolerance.
So Mr Roberts said he is “a little closer to buying emerging markets and selling high yield; closer, but definitely not there yet. It is too soon for me, but perhaps not for those with a bigger risk tolerance.”
