Investments  

Pressure on emerging market debt unlikely to ease

Intermediaries gained the ability to compare the performance of emerging market debt funds with ease for the first time on January 1, as the IMA launched a sector for the asset class.

The IMA Emerging Market Bond sector launched with an initial membership of 25 funds, most of which were previously in the Global Bond sector.

However, the sector launch followed a period of disappointing performance from emerging market debt funds, with many of them losing more than 10 per cent last year.

The losses came after US Federal Reserve chairman Ben Bernanke revealed last May that the Fed was set to reduce the pace of its giant programme of asset purchasing that had propped up the global economy through the financial crisis.

The remarks sparked a rout in emerging market bonds and many funds that buy the bonds fell by more than 10 per cent in a month.

The crash came after more than a decade of strong returns that barely slowed down during the financial crisis.

Nick Hayes, fund manager at Axa Investment Managers, said emerging market bonds had seen a lot of inflows for a long period of time, driven by policies such as quantitative easing, and said investors had overextended themselves, leading to the “big readjustment” that was seen last year.

JPMorgan Asset Management’s global market strategist, Kerry Craig, said that tapering was the major cause of poor returns from emerging market debt funds, but said investors were also spooked by lower growth from emerging markets, particularly in China.

However, Justin Oliver, investment director at Canaccord Genuity said tapering was only a catalyst for the drop and that the real cause was declining domestic fundamentals in emerging market economies.

He said emerging market companies had also experienced “falling profit margins and return on equity and deteriorating balance sheets” compared with US companies.

Mr Craig said the falls in 2013 had “created a lot of value”, particularly in dollar denominated sovereign bonds, although he said gains would only be “modest”.

But Mr Oliver said the poor fundamental trends are likely to continue until there is a significant upturn in emerging market productivity growth.

“The yield spread between emerging market bonds and developed markets has widened, but it has not yet matched the drop in commodity prices or relative underperformance of emerging market currencies,” he said.

Funds that invested solely in emerging market bonds denominated in local currencies underperformed those that invested in dollar denominated emerging market bonds in 2013.

This was because the dollar strengthened against most emerging market currencies, with some, such as the Indian rupee, performing poorly.

Mr Craig said he expected dollar-denominated funds to continue to outperform as the dollar is likely to keep strengthening against emerging market currencies.

The investable market for emerging market debt has grown by leaps and bounds, both in dollar terms and local currency, while inflows have poured in.

However, the second half of the year saw consistent outflows from emerging market debt and this will need to turn around for the asset class to start delivering returns.