The emerging market debt sector has been growing in popularity in recent months, as an area within the fixed income space with significant growth.
Indeed, the BofA Merrill Lynch Broad Local Emerging Markets Non-Sovereign index has risen by 21.15 per cent over the past year. US dollar denominated emerging market debt performed even stronger, returning 26.98 per cent in the 12 months to 20 February.
Performance of indices over 1yr
Source: FE Analytics
Colm McDonagh, head of emerging market fixed income at Insight Investment, says the asset class is a “broad universe” covering issuance from a range of different countries and corporates.
“Emerging markets have always been pretty interesting, they are especially so at the moment,” says the manager.
McDonagh – who joined the BNY Mellon subsidiary in 2008 – says recent events in developed markets, such as the US presidential election and upcoming European votes, have thrown up more headwinds.
One of the greater attractions of emerging market debt to some investors more recently has been the higher yields on offer than in developed market fixed income space.
Yields in the emerging market debt compare more favourably than other areas of the fixed income space such as European high yield bonds, McDonagh notes.
“In emerging markets... you have higher yield for less leverage than you get in developed markets,” he said. “[It’s a question of] how do I invest there and not get exposed to tail risks.”
One of the major changes for investors in the asset class during recent years has been greater flexibility over emerging market issuers’ currency regimes, he says.
“Major emerging market economies now have flexible currency regimes that they didn’t have in the 1990s and 2000s,” he explained. “If you don’t have a currency that’s flexible then GDP will collapse.
“In emerging markets there is a greater [ability] to adjust appropriately. While people who long currency might see some pain, it’s a far healthier adjustment than years ago.”
With the election of Donald Trump as US president and signs of potential increases in the Federal Reserve’s base rate, the low rate environment could be drawing to a close.
“Any time there is a hike in interest rates, people start to worry about the cost of capital,” said McDonagh.
“The jury is still out on whether there will be reflation and positive growth, in Europe growth is improving but there is concern about aggressive pricing of developed market yield.”
The fund manager said it remained to be seen whether there would be sustained increases in interest rates.
“If interest rates go up, you have to ask why they are going up. If there’s a dramatic repricing, then emerging markets will have to be repriced,” he added.
“Are we concerned? Parts of the emerging market universe will do quite well in that environment,” he said.
“Our job is not to figure out what the best countries are, [but] to invest in those with the best risk/reward,” he said. “As an emerging market manager you have to look carefully at the countries that have gone through turmoil like Brazil.”
McDonagh oversees two funds: BNY Mellon Emerging Markets Corporate Debt and Absolute Insight Emerging Market Debt.
The fund manager says he aims to stay away from index, giving it more flexibility to move into and out of areas where he sees greater potential and allows the strategy to avoid volatility in the market.
His $178.8m BNY Mellon Emerging Markets Corporate Debt fund aims to deliver a total return comprised of income and capital growth through investment in corporate debt and related instruments from emerging market issuers worldwide.
Over three years the five crown-rated fund has returned 60.96 per cent compared with a 28.15 per cent gain for the average fund in the IA Global Emerging Market Bond sector.
Performance of fund vs sector over 3yrs
Source: FE Analytics
The global aspect of the fund allows the manager to take a more global view of emerging markets rather than focusing on one specific geography.
The $834.9m Absolute Insight Emerging Market Debt fund, which employs a long/short strategy, has returned 51.68 per cent since launch in 2009, compared with a return of 32.40 per cent for the average IA Targeted Absolute Return fund.