Fidelity’s Steve Ellis has tempered his positive outlook on emerging market debt in light of the clouds gathering over the asset class.
“At the start of this year we were more optimistic on emerging market debt,” he said.
“There was a window last year where we saw it as a positive asset class; now we are more neutral.”
The manager of the $1.2bn (£768m) Fidelity Emerging Market Debt fund said he had moved to a more defensive position by adding protection ahead of the expected US interest rate rise.
This could be an important move given the fund is one of the few in The Investment Association’s 31-strong Global Emerging Markets Bond sector to have delivered positive numbers in the past year.
Mr Ellis will also be keen to protect the fund’s longer-term performance given it is ranked number one in the sector over one, three and five years to July 3, according to FE Analytics data. The manager has also produced top-quartile returns during his tenure on the fund since he took it over in November 2012.
“One thing we have done was reduce the credit beta from the start of this year,” he said.
“We found a lot of uncorrelated assets for our fund that will not be so affected when rates rise.”
Mr Ellis also pointed to the issue of liquidity in the bond market, which he called “quite a concern for investors at the moment”.
He said he had built up cash reserves and was focusing on newly-issued debt – which is likely to be easier to trade than existing bonds – to protect himself in the event of a widespread bond sell-off.
“Liquidity is so important at the moment; you have to have a cash buffer and have less illiquid instruments,” he said.
The key question hanging over emerging market debt is whether the US Federal Reserve (Fed) will raise interest rates in September and replicate a liquidity crunch in emerging markets similar to the ‘taper tantrum’ witnessed in 2013.
Mr Ellis also pointed to poor growth momentum and weak purchasing managers’ index numbers across parts of the emerging market world.
“It’s an unusual environment,” he said.
“Growth news has not been constructive for the asset class and the Fed is going to raise rates, adding uncertainty.”
But even now, for emerging market debt investors, “the positives are quite evident”, reflected by the “substantial” growth of the fund in the past year.
“In the long term people need that yield and want that diversification,” the manager said.
“There are pros and cons right now. I think it pays to batten down the hatches and remain defensive but I think opportunities are beginning to rise from this.”
These opportunities may appear in areas including dollar-denominated Hungarian bonds. Yields on these have risen in light of the uncertainty around the Greek bailout negotiations but they could once again see support if the crisis is resolved.
He also thought the nervousness surrounding the first US rate rise could throw up potential investments across emerging markets.
“On the first rate hike, that is an opportunity where you could buy in,” he said.
“I would say keep your powder dry now and wait for these opportunities – there will be quite a lot of them coming up.”
