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Fund Review: Emerging Market Debt

Introduction

Investment Association (IA) net retail sales figures for the past year show the IA Global Emerging Market Bond sector saw outflows in nine of the 12 months to March 2016.

In May 2015, the sector only attracted £1m in net retail sales. But could the £83m in inflows in March this year signal a turnaround?

The average return delivered by funds in the IA Global Emerging Market Bond sector has improved over the short term, according to FE Analytics.

Over one year to May 11 2016, it generated an average 3.7 per cent return, compared with the 8.2 per cent loss it averages over three years to the same date.

In the past six months to May 11, the average return from the sector jumps to 8.9 per cent, suggesting those investors who ventured back into emerging market debt funds in March did so on the back of recent performance and should have captured some of the upside.

John Peta, co-manager of the Old Mutual Local Currency Emerging Market Debt fund, says he became more positive about emerging market currencies in February and March this year as a result of three factors, one of which was Janet Yellen’s dovish language following the US Federal Reserve’s rate hike in December.

THE PICKS

SLI Emerging Market Debt

This offering from Standard Life Investments is one of the newer emerging market debt funds, following its launch in October 2012. The £113m fund is managed by Richard House with the objective to deliver income and growth. The majority of the portfolio is invested in bonds denominated in US dollars.

A geographical breakdown shows Latin America accounts for 35.8 per cent of the portfolio, central and eastern Europe for 18.1 per cent, while Asia makes up 17.5 per cent. In the past 12 months to May 12 2016, the fund has generated 9.2 per cent for investors, beating the IA Global Emerging Market Bond sector average of 4 per cent, according to FE Analytics.

Fidelity Emerging Market Debt

Steve Ellis has run this $1.2bn (£800m) fund since November 2012 after its launch in January 2006. The portfolio invests mainly in global sovereign and corporate emerging market debt. The emerging market debt team uses quantitative tools in the investment process that help to assess the attractiveness of countries.

The fund has outperformed its peer group, the IA Global Emerging Market Bond sector, over one, three, five and 10 years. Over five years to May 12, the fund returned 41 per cent, while the sector average return was 9.5 per cent.

EDITOR’S PICK

Pictet Global Emerging Debt

This £4.2bn offering from Pictet has clocked up several years of outperformance under manager Simon Lue-Fong. According to FE Analytics, the fund delivered 176.1 per cent over 10 years to May 12 2016, compared with the IA peer group average of 86.1 per cent.

The fund invests at least two-thirds of its assets in a diversified portfolio of bonds and other debt instruments issued or guaranteed by national or local governments of emerging markets. The portfolio has 6.1 per cent allocated to the Philippines and 4.6 per cent to Indonesia.

He also points to, “the bottoming of commodity prices, and the slowdown in Chinese economic growth and the Chinese currency’s regime shift, under which the Chinese authorities measured the renminbi against a basket of 13 currencies rather than simply against the US dollar”.

Chris Iggo, chief investment officer, fixed income at Axa Investment Managers, suggests “the stars are still aligned” for emerging market fixed income, citing “the combination of the bounce in commodity prices, a softer dollar and a cautious Fed”.

He explains: “Spreads on hard currency emerging market debt are around 400bps [basis points] above US Treasuries and returns have been strong so far this year, at around 6 per cent for sovereign debt.

“With sentiment towards China more stable than for some time, despite concerns about increased default risk in the Chinese onshore bond market, emerging markets overall are seeing renewed inflows.

“Given the dollar exposure of the hard currency debt market and the attractive spread on offer, it is little wonder that some investors have started to increase allocations to this asset class again.”

Luca Paolini, Pictet Asset Management’s chief strategist, is overweight sovereign dollar-denominated emerging market bonds, which are less volatile than their local-currency counterparts, he reasons.

He suggests being invested in dollar-denominated emerging market debt “enables us to capitalise on improved economic conditions in the developing world while remaining insulated from potentially turbulent conditions in the currency markets”.

The IA figures indicate investors may not have turned their backs entirely on emerging market debt funds, although whether the sector can continue to attract assets remains to be seen. Those invested in emerging market debt may have to be prepared to ride out some volatility and keep their eye on the long-term investment horizon.

In this special report