Between 4 September and 16 October, risk assets sold off as investors fretted about the prospect of QE’s end in the US, geo-political tension in the Middle East, continued economic weakness in the eurozone and the spread of the Ebola virus in west Africa.
Equities bore the brunt of the sell-off with the developed market-focused MSCI World dropping 6.61 per cent while the FTSE All Share fared even worse with a 9.71 per cent slide over the six-week period and the MSCI Emerging Markets index tumbled 9.52 per cent.
As investors pulled away from risk assets, they moved into perceived safe havens such as government bonds. The BofA ML US Treasury index, for example, rose 4.31 per cent during the equities sell-off.
Emerging market bonds, however, were dropped by investors due to their inherent risk. FE Analytics shows the JPM GBI-EM Global Composite index fell 2.62 per cent over the six-week sell-off, while the average fund in the IMA Global Emerging Market Bond sector was stronger with a 1.55 per cent loss.
Performance of indices and sector during sell-off
Source: FE Analytics
Macroeconomic forecasting consultancy Capital Economics argues that the sell-off could have left emerging market corporate bonds looking undervalued.
The group notes that the option-adjusted spread (OAS) on the BofA ML US Emerging Markets Liquid Corporate Plus index climbed to 348 basis points after the crisis, compared with 169 basis point OAS on the BofA ML US BBB Corporate index.
This is in spite of the emerging market debt index having a shorter duration of 5.2 years than the US index’s seven years, making it less sensitive to a rise in interest rates - which is one of the market’s biggest concerns.
John Higgins, chief markets economist at Capital Economics, said: “Amid the sell-off in ‘risky’ assets since the beginning of the second half of this year, dollar-denominated corporate bonds with similar ratings have suffered more in emerging markets than in the US. We think this makes little sense given their relative valuations.”
Swiss & Global Asset Management’s latest investment strategy report reveals that the group favours emerging market debt when it comes to fixed income, highlighting the asset class as an “attractive” alternative to government bonds.
Until the sell-off, emerging market debt had outperformed US treasuries with the JPM GBI-EM Global Composite index advancing 8.21 per cent against the BofA ML US Treasury index’s 4.78 per cent rise.
Swiss & Global Asset Management said: “In the current environment marked by positive economic growth in the US and the expectations this brings of rising US central bank interest rates, emerging market bonds in hard currency have done well.”
“Above all, the investment-grade segment has significantly outperformed US government bonds with a comparable maturity because of the attractive credit premiums during the period of interest rate volatility.”
The asset management house expects to see better yields to continue within the hard-currency segment of emerging market debt, but points out that volatility is likely to increase in the short term as more attention is paid to the timing of the Federal Reserve’s first interest rate rise.
Turning to where seems attractive, Alex Kozhemiakin, head of emerging market debt at Standish, says Latin American markets such as Brazil, Mexico and Colombia, along with South Africa, are some pockets of remaining value in the emerging market bond space.
“We view other local currency bond markets of the Europe, Middle East and Africa region as less fundamentally attractive and feel the Asian markets are expensive. In US dollar debt Standish favours some EMEA countries, including Kazakhstan where we see very good value in some quasi-sovereigns backed up by high oil prices,” he said.
The manager adds that quasi-sovereigns and corporates offer better value than sovereigns at the moment, especially when it comes to the larger, highly rated countries.
Rodica Glavan (pictured), emerging market debt portfolio manager at Insight Investment, agrees that eastern Europe doesn’t seem too attractive right now.
She said: “There is not an appealing level of diversification available in these markets just yet. Turkey and Russia may have more issuance than Hungary or Poland but of course, you have to be cognisant of what is happening in these countries at a political level.”
Glavan sees some value in China, Indonesia and Brazil, but concedes that other parts of the emerging market debt universe have started to look expensive given the strong investor interest of recent years.
However, finding a highly rated-fund to access emerging market debt could be difficult as none of the 27 funds in the IMA Global Emerging Market Bond sector are found on FE Research’s Select 100 list of preferred funds or Square Mile Investment Consulting & Research’s Academy of Funds.
However, two hold five FE Crowns - indicating superior performance in terms of stockpicking, consistency and risk control over recent times - while two are ran by an FE Alpha Manager.
Simon Lue-Fong and team’s $5.7bn Pictet Global Emerging Debt and the £75.4m Aberdeen Emerging Markets Bond funds are the two holding five crowns. Both have comfortably outperformed their peers over one and three years, with a lower maximum drawdown over three years.
In addition, FE Alpha Manager Matthew W Ryan is co-manager on the four crown-rated $3.7bn MFS Meridian Emerging Markets Debt fund, as well as the two crown-rated MFS Meridian Emerging Markets Debt Local Currency fund.
Performance of funds over 3yrs
Source: FE Analytics
Pictet Global Emerging Debt has an ongoing charges figure (OCF) of 1.42 per cent and Aberdeen Emerging Markets Bond’s clean charges are 1.15 per cent.
MFS Meridian Emerging Markets Debt has OCF of 1.56 per cent while Ryan’s fund charges 1.75 per cent.
