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Is there any point in holding emerging market debt funds?

18 November 2013

FE Trustnet looks at the pros and cons of investing in a sector that has taken a battering this year, asking the opinions of fund managers with differing views on the subject.

By Alex Paget,

Reporter, FE Trustnet

Experts are split on whether there is any point in holding emerging market debt funds after the sell-off of the past year.

According to FE Analytics, none of the emerging market debt funds in the IMA universe have made a positive return in 2013. The likes of Baillie Gifford Emerging Markets Bond, Pictet Emerging Local Currency Debt and Investec Emerging Markets Local Currency Debt have all lost around 10 per cent this year.

Performance of funds in 2013


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Source: FE Analytics

Our data also shows that investors have been pulling their money out of the asset class en masse over the past few months.

The Investec Emerging Markets Local Currency Debt fund is a good example. Before Ben Bernanke announced to the market that the Fed were considering tapering QE in May this year, the fund stood at £2.3bn.

However, at the time of writing the fund’s assets under management stand at just £1.4bn.

Fund of funds managers such as David Hambidge and FE Alpha Manager Bill McQuaker have expressed concerns recently about the outlook for the asset class.

They pointed out to FE Trustnet that with the tapering of QE expected in the not too distant future, investors in emerging market debt funds could face serious issues.
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However, Thanos Papasavvas, head of currency management at Investec, says that the worst is over for emerging market debt as the majority of hot money has already exited the asset class.

"The first point is that we have seen net inflows into the asset class this year. We have seen net retail outflows over the summer but inflows from institutional investors since May," he explained.

"Dedicated investor interest is still here, but there has been the reduction of interest from non-dedicated investors such as global fixed income managers, who just want some emerging market debt for its high yield."

"That money has now left and we think yields are now fair value between 6 and 7 per cent," he added.

Papasavvas says that prior to the May sell-off, he was concerned about the overvaluation of emerging market debt and thinks it is right that yields have corrected to their current levels. He applauds Ben Bernanke from stopping a speculative bubble in the asset class.


As a result, he says he is "very comfortable" over the outlook for the sector. He also thinks concerns over tapering have gone too far.

"We continue to like emerging market debt as not only are nominal and real yields attractive, but as and when tapering happens it will not have the same impact as the speech in May this year," he said.

"Tapering has already been priced into the fixed income market and we expect Janet Yellen to contain yields," he added.

Justin Oliver, investment director at Canaccord Genuity, is more bearish. He says that not only is there a lack of underlying liquidity in the asset class, but a huge amount of capital has rushed into emerging debt over the past few years.

"Where there could be another bubble is in the higher risk areas such as emerging market debt. Just look at how many emerging market debt funds have been launched over the last few years. That has more of a bubble characteristic," he said.

According to FE Analytics, 44 per cent of the emerging market debt funds in the IMA universe have been launched since 2010.

Oliver is concerned that as huge amounts of investor capital has flown into emerging market debt funds for short-term reasons, a lot of that money will want to come out in the coming years, meaning that investors who still have exposure to the asset class should reconsider their position.

"In certain parts, investors are just not being compensated for the risk they are taking," Oliver explained.

"With developed market government bonds, all investors hate them – us included – but you can understand why their yields are down there."

"Liquidity is one of the things we always look at when making an investment and we always question what would happen if everyone wanted to get out of emerging market debt funds."

"However, the major warning sign is when fund management groups who have no prior experience or ability of running funds in an asset class announce that they too will launch an emerging market debt fund."

"That’s when we will take our money somewhere else and say 'thank you very much'," he added.

However, Howard Cunningham (pictured), manager of the Newton Global Dynamic Bond fund, says he expected even more money to come out of emerging market debt funds in September and that the sell-off wasn’t as bad as he expected.

"There has been a drip, drip, drip of money coming out, but I was more concerned that there would be huge outflows in September," Cunningham said.

ALT_TAG "Not everyone has daily liquidity so there was the risk that investors may wait until the next quarter to pull their money out, but that didn’t happen. The lack of tapering probably had an impact and there is a sense of a more risk-on environment."

"Clearly a lot of money flowed into emerging market debt though, and the question is whether there are more people who are willing to stay in the asset class for longer," he added.

Cunningham says he is uncertain about the asset class's outlook. He has chopped down his exposure to emerging market debt from 20 per cent to 8 per cent over the past few months and says the majority of his remaining positions are short-dated.

"It’s not certain what the outcome will be. Those countries’ fundamentals are improving but at the same time there is a lot of hot money flying around," he added.


Peter Eerdmans (pictured), manager of the Investec Emerging Markets Local Currency Debt fund, admits that fears over the Fed’s tapering have caused a sell-off and that yields could continue to rise over the short-term. However, he says that worries about the future of emerging market debt funds have been overplayed.

ALT_TAG "Our core scenario, which we believe is somewhat conservative, is for an annualised return of 5.8 per cent for local currency emerging market debt over the next five years," Eerdmans said.

"Even if yields rise to 8.75 per cent and emerging market currencies lose 5 per cent per annum, local emerging market debt should deliver an annualised return that is positive. Our projections for local EMD are certainly ahead of our expectations for returns from developed market bonds," he added.

Eerdmans says that while the Fed will inevitably begin to scale back its asset-purchasing programme, he doesn’t expect to be as aggressive as some experts believe.

He also says that the economic recovery in the likes of the US, UK and Japan is likely to have a positive knock-on effect for the developing world. The FE Select 100 contains the Threadneedle Dollar Bond emerging market debt fund, which invests exclusively in bonds that are denominated in dollars rather than emerging market currencies.

It also holds the M&G Global Macro Bond fund, which has the ability to invest in emerging market bonds as well as developed market bonds, but is currently very heavily into developed market debt.

Click here to learn more about bonds, with the FE Trustnet guide to fixed interest.

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