July 2008

FUND LAUNCHES: the emerging safe havens

Emerging market fund launches in Q2 might indicate a desire for risk. But volatility is an issue for the many pension plans that want to avoid it, finds Nick Fitzpatrick Advisers might have expected fund managers to bombard retail and institutional investors with safe money market funds, given the background of choppy capital markets in recent months. But if fund launches are any indicator, there is still an appetite for risk out there as seen by the amount of emerging market products that have been released in Q2 this year.

Legg Mason and HSBC Global Asset Management pushed out emerging market funds in June, while The Bank of New York Mellon has launched an Asian fund with Vietnam as a major target, and Investec continues to emphasise Africa.

“There is still a lot of appetite for risk and emerging markets are benefiting,” said one fund manager. “It’s almost a cliché, but perhaps it’s further evidence that people are swayed by the decoupling story.”

Legg Mason launched the Batterymarch Emerging Markets Equity Fund into its Dublin-domiciled Legg Mason Global Funds plc range in June. Benchmarked to the MSCI Emerging Markets Index, the fund aims to provide long-term capital appreciation using a bottom-up, model-driven process.

The case for long-term capital appreciation is seen in the stream of data that emanates from emerging markets. According to Batterymarch, an affiliate of Legg Mason, emerging economies represent more than 80% of both world population and land mass, nearly 70% of foreign reserves, more than 50% of GDP – but still less than 10% of market capitalisation. Emerging markets should therefore continue to grow strongly both through price appreciation and new equity supply, the firm believes.

Legg Mason also says that its process analyses over 1,750 stocks on a daily basis with team members selectively adding opinions where information is difficult to capture quantitatively.

The fund will invest at least 70% of its total asset value in equity securities, including common stocks and preferred shares, or companies whose seat, registered office or principal activities are in emerging market countries.

HSBC Global Asset Management has launched an emerging market inflation-linked bond fund out of Hong Kong through its Sinopia Asset Management quant house.

Inflation risk
Patrice Conxicoeur, CEO of Sinopia Asia Pacific, says that there has been a shift by investors to safe harbours such as bonds, but adds that while bonds may offer stability in this environment, inflation is a serious risk as it reduces the returns from bonds over time. “Despite slowing global growth, economic growth and inflationary pressure remain strong in emerging markets, with expected growth and inflation rates of 7% and 6.6% in 2008 respectively.”

The actively managed fund will invest in a portfolio of inflation-linked bonds issued by various emerging markets, including Brazil, Chile, Colombia, Mexico, Poland, South Korea, South Africa and Turkey. Different from conventional bonds, for which the principal repaid upon maturity remains unchanged, an inflation-linked bond has its principal indexed to inflation, and thus the principal and coupon payment will increase over time in an inflationary environment.

The bonds that HSBC selects are also denominated in local currencies. Conxicoeur says that emerging markets inflation-linked bonds will also benefit from the potential appreciation of local currencies, which have delivered strong performances in recent years and the trend is likely to continue.

Safe haven
Of course, the pursuit of emerging markets may not be about hunting for risk. If the decoupling theory is correct, investors may now view emerging markets as at least a temporary safe haven from economic troubles in the developed world.

Christian Deseglise, global head of emerging markets business at HSBC Global Asset Management, said in a recent report: “While it would be premature to assume that emerging markets will be entirely immune from a US recession, the economic and earnings environment in emerging markets is likely to remain favourable, especially relative to the prevailing conditions in the developed world.”

But he warns that if demand from the US, Europe and Japan falter simultaneously, emerging markets would most likely also suffer. Unfortunately, such a scenario cannot be ruled out. But, even in such an environment, emerging markets are likely to fare better than their developed counterparts in the medium and long term, he says.

Deseglise also notes that volatility is likely to remain high until the US economic outlook improves.  This is a significant issue for pension plans. A global poll by SEI, a US-listed asset manager, found that risk avoidance and managing volatility are the top priorities for  company sponsors in the wake of the credit crisis and the ongoing turbulence in the capital markets. In fact nearly two-thirds (62%) of those polled globally said decreasing volatility in their investment portfolios while maintaining current returns was a higher priority than increasing returns whilst maintaining current volatility.

Demand for liquidity funds
Products from other fund mangers in the past three months are more in tune with this. James Finch, BGI’s head of cash sales, EMEA, says: “In the current environment, we have seen increased demand for liquidity funds managed to AAA ratings and in particular government-only cash funds.” BGI launched the Euro Government Liquidity Fund, a Government-only cash fund in April, as well as a dollar-denominated inflation-linked bond fund.

State Street Global Advisors (SSGA) launched a range of diversified growth strategies in the last quarter which are designed to reduce volatility by offering access to a wide range of asset classes with, predominantly, passive management.

Greg Ehret, co-head, advisor strategies group at SSGA, believes the strategies could provide the ideal default fund option for defined contribution pension schemes.

“We wanted to provide a diverse basket of beta at a relatively low cost. There are places where betas can be used to make active decisions and these different betas can be used as alpha sources,” he says.

Whether fund launches in Q2 point to any emerging trends or not, they at least show that the industry can provide a little something for everyone. © funds europe 2008

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