Bond managers wary of EMD despite Brexit effect

The typical EMD fund has returned 22 per cent in sterling terms this year, according to FE Analytics, aided by the pound’s slump following the June 23 referendum.

Other bond markets have also had a good year, but with a significant proportion of European bond yields now at or below zero, managers seeking income have seen their investment options narrow.

Steve Ellis, co-manager of the Fidelity Emerging Market Debt fund, claimed that his area of focus could see a revival because of the superior yields on offer.

“Brexit has galvanised ideas that [rates] are going to be very close to the zero bound, or negative in the case of the European Central Bank, for a protracted period of time,” he said.

“Therefore, you need that diversification and yield from something else, and that’s forcing people to look for alternatives. Emerging markets have been under-allocated by UK managers for some time.”

BlackRock’s EMD team has also predicted a “great migration” to the asset class, saying both local currency and dollar-denominated EMD look attractive now growth “finally shows signs of improving and external balances are much stronger after three years of adjustment”.

Tom Ross, co-manager of Henderson’s Credit Alpha fund, is considering upping exposure to some developing countries and said fixed income instruments in emerging markets typically yielded above 6 per cent.

But he noted the mainstream US high yield market is also offering a 6 per cent yield, and stressed the need for “expertise” when investing in EMD.

“There are still clearly some risks there,” he said.

“We are watching oil, which is around $42.50 (£32). People think it’s now in a range of $40 to $60. We could be at the bottom of the range or [markets are wrong and] there’s more downside risk.”

Investec Asset Management’s Russell Silberston added: “It’s a search for yield but what people are doing [by entering emerging markets] is taking currency risk. It’s a falsehood to say you can just get paid an extra yield.”

Chris Higham, head of credit multi-strategy fixed income at Aviva Investors, said some UK fund managers were beginning to allocate more to emerging markets, but added restrictive fund mandates could limit the scope of this shift.

He also pointed to the US corporate bond market as offering an attractive alternative.

Some investors – such as Rathbones strategic bond manager Bryn Jones – already allocate to EMD, but not because of a bearish view on the UK and Europe.

“I like emerging markets because structurally, and in longer periods, it gives us better risk-adjusted returns,” he said. “It’s too early to call on Brexit.”