Attractive spreads in emerging market debt (EMD) mean investors are finally being paid adequately for the risk that they’re taking, according to Rathbone’s David Coombs (pictured). 
The head of multi-asset investments has bought three funds that invest in the asset class, thereby bringing his emerging market exposure up to more than 3 per cent across his portfolios.
While this means he is still underweight overall, it is a significant increase compared to just two months ago when the manager upped his overall exposure to 1.5 per cent following the global stock market sell-off that triggered ‘Black Monday’.
Performance of indices in August 2015
Source: FE Analytics
“We look back at taper tantrums or Lehmans or the dotcom bubble or the Greek debt drama and there’s usually some kind of underlying crisis that creates this sort of panic,” Coombs told FE Trustnet last month.
“The fact is that [the sell-off] happened in August and volumes were relatively low and I think high frequency traders have had a bigger impact on the market than maybe they do at other times.” “I don’t understand why the fact that China is slowing is creating this effect. Everyone knew China was slowing. Most big corrections are due to a shock and I don’t know what the shock is here.”
Almost two months later, Coombs remains more positive on China than many of his peers as the growth slowdown and subsequent market sell-off came as no surprise to himself or his team.
He has believed that Chinese growth would slow down for the last two years, which is why he has been significantly underweight both emerging markets and commodity stocks.
“The Chinese government clearly indicated that they wanted to move away from an investment-led economy and into a consumer-led one, and we felt that while they made that conversion there would be some policy errors and there would be some bumps in the road in terms of growth,” he explained.
“What’s been happening has come as no real surprise to us; I think the market has been unrealistic in its expectations for Chinese growth. I just can’t see China growing at 7 or 8 per cent again to be honest.”
Instead, Coombs predicts that China will see a trend growth of between 4 and 5 per cent and that, when the market gets a “sense of realism”, it will still regard this as a solid rate of growth for such a large economy.
As such, he has continued to increase his emerging markets exposure further still and has done this through fixed income funds, as he says the asset class offers greater yields and lower levels of volatility than emerging market equities.
“It’s a less risky way in,” he said. “We have currency exposure in certain parts because we’ve bought a local currency fund as well. We’ve bought 0.7 per cent of local currency debt fund at the moment.”
“Basically, if you’ve got the certainty, default aside, of a coupon then that reduces your risk somewhat to that area.”
Coombs has further aimed to reduce risk levels by choosing three EMD funds that cover different areas of the market, having bought one government fund and two credit funds.
The government fund he recently purchased is Investec Emerging Markets Local Currency Debt, which has been managed by Peter Eerdmans since 2007 and co-managed by Werner Gey van Pittius from 2012.
Over Eerdman’s tenure, the fund has returned 49.15 per cent, underperforming its benchmark and sector average by 8.69 and 11.75 percentage points respectively.
Performance of fund vs sector and benchmark under Eerdman
Source: FE Analytics
However, the £841m fund has an FE Risk Score of 78, which suggests that the fund has shown only 78 per cent the risk of the FTSE 100 over recent years. It also has a current yield of 5.7 per cent and a clean ongoing charges figure of 0.89 per cent.
The other EMD funds that Coombs has bought recently are Ashmore Emerging Markets Short Duration and JB Emerging Markets Opportunities Bond Fund, which was launched by GAM in March last year and is managed by Enzo Puntillo.
“These choices are not fund specific, but more asset class specific,” Coombs explained.
“I just wanted to have the broadest exposure possible and all three invest in very different strategies. Investec invests in government debt, the Ashmore is in credit but short duration and the Swiss & Global fund is a normal credit bond fund with no duration limits.”
“They’re three very different strategies and I’m trying to spread the risk across those so I don’t have too much exposure to any one county, corporate or level of duration. It’s such a volatile area right now and it’s so open to swings in sentiment, so I’m just trying to spread that exposure as much as I can.”
While Coombs admits that EMD funds have been in the doldrums over the last couple of years, he says there does seem to be some value there now.
He adds that, as long as the manager that is being invested in has a vast amount of experience in the asset class and defaults are avoided, investors are starting to be rewarded for the risks they are taking.
“Compare it to other bond markets and it just feels that you are starting to be paid for the risk whereas, if you look at high yield and investment grade you could argue that the returns are possibly a bit modest with the liquidity risk that you’re taking.”
Performance of manager vs peer group composite over tenure
Source: FE Analytics
Coombs, who co-manages five funds including Rathbone Strategic Bond and Rathbone Total Return Portfolio, has outperformed his peer group composite since managing funds at Rathbones by 9.66 percentage points, providing an average return of 51.28 per cent.
