Ian Edmonds has overhauled the emerging market debt portion of his Legg Mason Global Multi Strategy Bond fund after the position dragged on performance this year.
The fund, run by Mr Edmonds and his team at Western Asset Management, has slipped into the third quartile in the IMA Global Bond sector for one and three years.
The manager said this was due principally to the fund’s high exposure to emerging market debt, which has been the highest weighting in the fund throughout the year.
Emerging market bonds suffered particularly badly during May and June this year when the US Federal Reserve aired the prospect of reducing its quantitative easing programme.
Most UK-domiciled emerging market debt funds fell by more than 10 per cent during the period, and the asset class has yet to recover fully.
However, Mr Edmonds said the asset class now looked very attractive from a valuation point of view. As such, it is by far the largest weighting in the fund, at 35 per cent.
The manager has also recently been rotating his holdings out of dollar-denominated emerging market corporate debt and into dollar-denominated emerging market government bonds.
He said: “Recently, corporate bonds have outperformed sovereigns, so I have started to switch back into sovereign issuers in dollar terms.
“I have been investing in countries such as South Africa and Hungary, where you can get 5 or 6 per cent yield on bonds that are 10 to 12 years in maturity.”
Mr Edmonds said he preferred the dollar-denominated debt rather than local currency debt due to the additional risk from currency movements for the latter.
The switch to emerging market sovereign bonds has coincided with Mr Edmonds decision to reduce the fund’s exposure to developed market investment-grade bonds, which he said now look expensive.
The manager said emerging market government bonds have a greater spread in yield terms above developed market government bonds than developed market investment-grade corporate debt. The spread is the difference between the yield of a bond and that of – usually – Western government bonds such as US Treasuries or German bunds.
Given that many emerging market countries now have credit ratings better than a lot of developed market companies, Mr Edmonds said this wider spread represents an attractive buying point.
Fund buyers’ views on emerging market debt
Jason Hollands
MD of business development and communications at Bestinvest:
“Emerging market debt issuance has been rampant since the US began its QE programme. Tapering is likely to be a major theme during 2014 and US Treasury spreads should widen, which will trigger a repricing of risk elsewhere. Significant headwinds are facing emerging market currencies and we expect to see a big disparity in performance between local currency funds and dollar-denominated bonds. In our view, the risks outweigh the rewards.”
Denise Collins
Investment manager at City Asset Management:
“Our view is relatively negative. Emerging market debt had a poor 2013, particularly hard currency bonds, which were a victim of their correlation with US Treasuries. The asset class looks cheaper, but sovereign debt will likely continue to underperform, assuming US Treasuries continue to reprice. Shorter-maturity bonds should mitigate interest rate volatility, and diversification is key, but the asset class remains vulnerable.”
Adrian Lowcock
Senior investment manager at Hargreaves Lansdown:
“If it keeps sliding, it will start to look interesting. But the best way to access emerging market debt for most investors is through a global bond fund, where the manager can tactically allocate to emerging markets. It is hard to know when will be the right time to buy in; no one knows where the bottom of the market will be.”
