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.
Mr Hayes said he had been buying back into the asset class with his Global Strategic Bond fund at the end of last year, but only slightly and mainly in bonds with higher credit risk but with a short duration so that they will be less likely to fall in value if interest rates rise.
However, the asset class remains vulnerable both to the tapering of quantitative easing in the US and subsequent rate rises, as well as the continuing negative sentiment towards emerging markets in general.
New launches help emerging market sector growth
While the returns from emerging market bonds have been poor in the past year, it is difficult to argue with the need for the sector, which already numbers 25 funds and is likely to grow if the large number of new launches seen in recent years continues.
As it did with the first open-ended fund ever launched, M&G once again led the way, launching the first UK retail emerging market debt fund in 1999.
However, the fund has failed to generate much traction and is still only £32m in size, which is probably why M&G swooped in to hire manager Claudia Calich away from Invesco Perpetual late last year.
She has a lot of experience managing emerging market fixed income funds and had run Invesco’s Emerging Market Bond fund since June 2004.
Another big-name manager move within the sector occurred when Standard Life Investments poached Richard House and his team from Threadneedle Investments.
He had built up a strong reputation at Threadneedle since launching its Emerging Market Bond fund in 2008, but he moved to SLI in 2012 and is now managing its Emerging Market Debt fund.
The amount of money in onshore funds is still small, with Investec’s Emerging Markets Local Currency Debt fund the largest at £1.4bn.
Are emerging markets the ones to watch?
Gavin Haynes, managing director of Whitechurch Securities.
“Investec has got a very highly experienced team and a long track record. We also like the local currency aspect of the fund.
In the long term there is a big structural investment case in emerging market currencies and there is a good investment opportunity.”
Rob Burdett, co-head of multi manager at F&C Investments
“We have had no pure emerging market debt plays. The nearest exposure that we have is the Liontrust Global Strategic Bond fund, run by Mike Mabbut.
We think there is some value in the sector, but we want to have an expert manager between us and the asset class.”
Denise Collins, investment manager at City Asset Management
“Within the sector, we like the capabilities of First State. We feel it has great expertise in these geographical regions. While the fund produced a negative absolute return it outperformed significantly relative to the IMA peer group
