How to dampen volatility in emerging market debt
Minimising single-stock positions and avoiding local currency exposure are among the best methods of protecting against downside risk in the sector.
By Jenna Voigt, Features Editor
Friday October 12, 2012
Emerging markets have become more stable as the investment universe in the sector has widened, according to Invesco Perpetual’s Claudia Calich
Calich says an important aspect of dampening volatility in her $351m Invesco Emerging Markets Bond
fund is keeping single-stock positions relatively small. She added that having more stocks to choose from has helped not only to deliver strong returns, but to keep the volatility low compared with her peer group.
"The investment universe has broadened significantly," she explained. "It is much wider now than it was in 2004, which is good because it gives us more to choose from."
Calich’s $351m Invesco Emerging Markets Bond fund is the only one in the IMA Global Bonds
sector to deliver top-quartile returns over the two consecutive five-year periods since 2002
, according to FE Trustnet
Performance of fund vs sector and index over 10 yrs
Source: FE Analytics
The four crown-rated fund typically holds between 20 and 25 per cent in emerging market corporate bonds, and Calich stressed the importance of keeping individual allocations small to dampen volatility.
According to FE data, the manager's biggest single position – a Colombian government bond – has a 3.2 per cent weighting.
Nearly 40 per cent of the fund is invested in BBB rated bonds, with the majority of the regional allocation in international paper.
Calich says she is holding fewer bonds denominated in local currency because of risks to developed markets over the past few years, which could have an adverse effect on local currency bonds.
However, she has picked up holdings in “more exotic” countries that have recently entered the emerging market investment sphere, such as Angola and Zambia.
The manager adds that she increased her allocation to Venezuela following the market weakness after the results of last weekend’s election.
Calich expects emerging markets to continue to outpace developed markets in terms of growth in the coming years.
The MSCI Emerging Markets index has returned more than double that of the FTSE 100 over the 10-year period and more than tripled the output of the S&P 500 over the term.
However, the emerging markets index has underperformed the US blue chip index over one, three and five years, raising questions over which region will be the primary driver of growth for the global economy.
Performance of indices over 10-yrs
Source: FE Analytics
"Developed markets have several constraints to growth," Calich said.
"If you look at the flip-side, you don’t see those constraints in emerging markets. The credit side is quite healthy and there is no need to shrink fiscal deficits. They are at quite sustainable levels."
However, she admits some countries are growing below their potential as the slowdown in the developed world has taken a toll on export consumption.
She is avoiding countries such as Belize, which is restructuring its debt, and countries in the Middle East, such as Iraq and Lebanon, where geopolitical concerns make investment too risky.
Calich adds that countries in eastern Europe, such as Bulgaria and Croatia, which are closely tied to the fate of the eurozone, also offer few investment opportunities.
Invesco Emerging Market Bond has a minimum investment of $1,500 and an annual management charge (AMC) of 1 per cent. The TER of the fund is 1.28 per cent and it is currently yielding 4.91 per cent – a top-quartile figure in the IMA Global Bond sector.