Opportunities are there in emerging market debt

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Emerging Market Debt - May 2014

The strong performance of emerging market debt (EMD) in the past couple of years, and the ensuing raft of fund launches targeting this area, resulted in the creation of its own IMA sector at the end of 2013, just in time to record a terrible year for performance.

The sector launch was part of a larger overhaul of the fixed income sectors, but by the time the sector came into effect on December 31 the fortunes of these funds had significantly reversed following the suggestion of tapering by the US Federal Reserve.

For the 27 funds listed in the IMA Global Emerging Market Bond sector, the first five months of last year was strong, delivering a sector average return of 6.7 per cent from January 1 to May 22.

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However, Ben Bernanke’s testimony to the Joint Economic Committee on May 22 last year, in which he noted “if we see continued improvement and we have confidence that is going to be sustained, then we could in the next few meetings, take a step down in our pace of purchases”, caused significant market volatility.

The second half of the year was less pleasant for emerging market debt investors, with a sector average loss of 15.1 per cent from May 22 to December 31, according to data from FE Analytics.

Simon Lue-Fong, head of the emerging markets debt team at Pictet Asset Management, notes: “Emerging markets have had a bit of a rough period since May 22. The reasoning for the sell-off, in my view, was threefold.

“Treasury yields going up because of the withdrawal of QE raises the funding costs for emerging markets, so people were worried about funding costs. Secondly emerging market fundamentals –even prior to Mr Bernanke speaking – were not as strong as they had been, so you had growth slowing. Then you had a current account for many of these countries that had gone from either surplus or a small deficit to a much larger one.”

The latter reason resulted in the phrase “fragile five” as the focus was on countries with large current account deficits, as you have to fund the deficit and as costs go up the risks go up.

A year later, however, and while dollar-denominated emerging market debt – hard currency EMD – has recovered almost to pre-Bernanke levels, local currency EMD, seems to have fared less well.

But Robert Simpson, portfolio manager in the emerging market debt team at Insight Investment, notes that the improved policymaking in some emerging market countries, such as the ‘Fragile Five’, has helped fuel a recovery in emerging market assets in 2014. He notes: “Since the market forced their hands we have seen improved policymaking, particularly from Indonesia and India.”

Figures from FE show that the IMA Global Emerging Market Bond sector has moved into positive territory for the year-to-date to May 8 with an average return of 2.57 per cent, ahead of the IMA Global Bond sector average of 1.74 per cent.

The drastic improvement is demonstrated by the fact that no fund in the sector delivered a positive return for the 12 months to May 8, but for the year-to-date all the funds bar one delivered a positive return, ranging from 0.45 per cent to 6.16 per cent.