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Magazine Issues » November 2009


Emerging market equities may still be popular, but the improving debt profile of many countries is boosting the case for emerging market bonds too. Angele Spiteri Paris talks to fund managers focusing on the sector...

emerging.jpgEmerging market debt instruments are gaining traction with investors, as these regions not only have major growth potential compared to emerged economies, but they are also sound from a fundamental point of view, argue investment managers.

According to Lipper FMI, a research firm, emerging market bonds in Europe saw €1.6bn of inflows between January and August this year – a figure up around €245m compared to the same period last year.

Furthermore, the US$967m (€84.3m) of inflows into emerging market bond funds on a global level during the second week of October was the biggest weekly total since the first quarter of 2001, according to EFRP Global, a research company that has been tracking this data since that date.

So it seems emerging markets are proving to be the winners in a post-crisis environment and, according to the experts, the road ahead only gets brighter. Emerging market specialist firm Rexiter forecasts over $10bn will flow into the asset class over the second half of 2009.

Cristina Panait, an emerging market strategist at Payden & Rygel, a manager with around $1bn in emerging market debt, says: “What’s happened over the past twelve months showed that emerging markets have passed the test and were able to react. Ultimately, this was not an emerging markets crisis, unlike in the past when you had major currency depreciation and interest rate hikes.”

Leonardo Da Costa, a portfolio manager from Newscape Capital, a newly launched boutique, says: “Unlike prior crises, emerging market economies are now more flexible. Freely floating currencies, low indebtedness and a focus on developing domestic yield curves have allowed them to adjust rapidly to the changing global environment.”

John Morton, Rexiter CIO of fixed income, says that credit conditions and debt compositions in emerging market countries have significantly improved and debt instruments provide strong risk-adjusted returns.

The growth story backing emerging markets has done the rounds over and over again, but the macro-economic picture always fuelled any niggling doubts. But any misgivings can be put to rest post-crisis.

Panait, of Payden & Rygel, says: “From a macro standpoint they [emerging markets] have lower debt burdens, lower budget deficits and their current account balances are in control. Even though there have been some challenges with the crisis, overall everything they’ve done over the past five years – accumulating foreign exchange reserves and trying to improve their debt profiles – all those improvements are there and are going to help them going forward.”

The crisis allowed these countries to prove that the developments they made are sound. Greg Saichin, head of emerging markets and high yield at Pioneer Investments, says: “Many countries made a lot of progress to reform and create a framework for macro stability. That has ultimately resulted in the creation of long-term capital markets and long-term capital flows in local currency instruments.”

Pioneer is in the process of launching a local currency emerging market debt fund. Saichin says the firm has had the idea of launching such a fund for two years, but as things began to deteriorate in 2008 the project was put on hold. “On this side of the crisis, we think that local currency as a sub-asset class of emerging markets has a long way to go and it’s good timing for us to do this,” he says.

The firm currently has €297.7m in emerging market debt assets.

One of the biggest selling points encouraging an emerging market debt allocation at this point in time is that the spread levels are currently very attractive.

Panait, of Payden & Rygel, says: “If you look historically, the level of spreads we are seeing today, which is about 350bps over US treasuries, takes us back to around 2004 levels. At that time the asset class was rated one notch lower than what it is today.”

She says it could be argued that if higher rated products are obtainable at the same spreads as five years ago, there is more value.

Country differentiation
But, of course, not all emerging markets bonds hold the same attraction.

Da Costa, of Newscape Capital, says: “A large amount of differentiation between emerging market countries has taken place as the asset class has developed, even intra-region. With deeper and more accessible markets investors have been able to distinguish between improving and deteriorating countries and allocate accordingly. Brazil and Indonesia both offer attractive local real rates and, having strong, unlevered banking systems, have been able to recover quickly from the crisis. Being commodity producers they also benefit from strong growth in China.”

According to F&C, countries in Asia and Latin American could perform better than their industrialised counterparts. In a report the firm, which runs a $119m emerging market bond fund, said: “Their growth potential received a boost from market-friendly reforms introduced during the last business cycle.

“Additionally, the healthy exchange reserves accumulated by many emerging market countries during the commodities boom can be used to cushion against any future adverse market conditions.”

Payden & Rygel is also of a similar opinion. Kristin Ceva, head of the firm’s global fixed-income group, says the countries seeing a rebound in GDP growth are those without fiscal deficits and structural problems.

Brazil, again, is one such example as its GDP was up almost 2% in the second quarter of this year.

Within Latin America, Ceva said she sees market opportunities in local currency debt in Brazil and Mexico. In terms of dollar-denominated issues, Ceva preferred a selection of sovereign credits in Brazil, Colombia and Peru, as well as higher yielding countries like Uruguay and Venezuela.

But she is staying away from Eastern European debt. “This area still has problems to overcome in terms of deleveraging,” said Ceva. “The levels of household debt are still quite high.”

She added that by buying sovereign debt, the firm is investing in a country and this offers diversification benefits. “You can get high quality BB+ or BBB- bonds, but with sovereign spreads,” Ceva said.

All the experts spoken to agree that at this point in time, investors cannot afford to not have an allocation to emerging markets, with debt instruments providing one of the safer ways of doing this.

Saichin, at Pioneer, concludes: “The fundamental principle behind investing in emerging markets is that if you look at the future of global growth, the balance has shifted from the so-called developed world to the emerging worlds. Over 50% of global output is going to be on the side of emerging markets.

“The demographic balance is also in these regions’ favour because the largest part of the youngest part of the global population live in emerging market countries, and as incomes grow, the ability to consume in those countries also grows.”

©2009 Funds Europe