Things are looking very promising for emerging markets as currencies are no longer overvalued, most countries are starting to reduce their fiscal deficit and fundamentals are stabilising, according to M&G’s Claudia Calich. 
The manager, who runs the five FE crown-rated M&G Emerging Markets Bond fund, highlighted that, as opposed to previous years when they looked more expensive, bonds that are issued in local currencies are currently offering value.
She pointed out a great number of currencies are looking back to fundamental value levels or “looking cheap”, a reason why she is showing preference for local-denominated debt as opposed to that issued in “more mainstream currencies like the euro”.
“I do like both emerging and frontier markets’ local currencies. Although when you look at the fund’s overall numbers you may not see it, I have a small overweight in bonds that are issued in local currencies,” Calich said.
“In terms of emerging markets’ interest rate differentials from the dollar perspective, we have seen an increase in real yield, not only in the US but also in emerging markets as well, which is supportive for the developing economies’ numbers,” the manager explained.
Local currency emerging market debt has enjoyed a decent run over recent years, returning 14.22 per cent over the past 12 months and 21.49 per cent over three years, in US dollar terms.
Performance of indices over 3yrs in US dollar
Source: FE Analytics
Another sign emerging markets’ currencies are still attractively valued, she said, is the commodity currencies’ rebound in value.
“Oil prices and metals have, to some extent, rebounded, which is supportive for selected commodity currencies including some of the emerging markets’ currencies”
As such, Calich has been increasing M&G Emerging Markets Bond’s exposure to local currency debt, which is at the highest level since she took over the fund in 2013.
“I had about 10 or 15 per cent of the portfolio in local currency debt until 2015 and, since then, it’s been raised to 40 to 45 per cent”, she pointed out.
Recent additions to the portfolio, Calich said, have been more liquid and highly traded local currencies including the Mexican peso, the Russian ruble, the Brazilian real and the South African rand.
The FE Alpha manager has also increased exposure to currencies “driven up by bottom-up fundamentals” such as the Kazakhstani tenge, the Ukrainian hryvnia and the Dominican peso.
“Unlike the major liquid countries, the Kazakhstani tenge, the Ukrainian hryvnia and the Dominican peso are less correlated, much more driven by what’s going on in those countries,” she explained.
“Thus, from a portfolio perspective, it is very important to have different correlated assets, to have some parts of the portfolio that are moving and some parts that aren’t.”
Among the main reasons behind her positive outlook for emerging markets is that after several years of deterioration, Calich sees fundamentals as finally stabilising in most emerging countries.
“The fiscal deficit has been relatively high in sub-Saharan African countries, partly driven by the collapse in certain commodity prices and partly driven by the easy spending and the governments taking relatively benign fiscal measures to smooth out the recession,” she said.
“Thus, as commodities fell we saw a weakening of the currencies and higher inflation, which was very negative.”
However, the current environment of generalised global growth is seeing fiscal deficit starting to lessen in some countries, which is “very important from the perspective of a bank holder”, Calich added.
“If deficits remain high and sustainable it could be very damaging for the country’s credit ratings and could potentially lead to downgrades and credit spreads,” she said.
“Weaker currencies and higher yields on the local debt could also be the result of high fiscal deficit, facts that can be very negative to growth.”
But when it comes to growth expectations, Calich said things are looking rosier for emerging markets, with fiscal numbers improving in numerous countries and growth starting to peak in areas of South America or some Asian countries like Sri Lanka.
Although she is positive on the outlook for fiscal numbers in the majority of the emerging markets, Calich also acknowledged the importance of being cautious on certain countries, such as Turkey, where she said the account deficit is still high.
Indeed, Turkey ’s current account gap is the biggest in major emerging markets. Bonds denominated in Turkish lira are being hit by concerns of over-heating economy after its currenta ccount deficit reached $50.6bn in January on a 12-month rolling basis, up from $47.2bn in December, data from the World Bank and the IMF show.
“Turkey that has seen a very little reduction on the account deficit as opposed to India, Brazil or Indonesia,” Calich said.
“Not only its account deficit is high but if you look at interest rates, they are still very low compared with other emerging markets and there is a very high level of inflation.”
Thus, given the volatility of the Turkish lira, its geopolitical risks and the countries’ dependency on external financing, the manager has decided to keep the fund exposure to this country at minimal levels.
Indeed, Turkey is not among the fund’s largest issuers. The latest factsheet shows the fund has around a 60 per cent allocation to US dollar-denominated bonds, with the rest of the portfolio allocated to local currency denominated debt including Singapore dollar, Russian ruble, Indonesian rupiah, Indian rupee, Brazilian real, Peruvian nuevo sol, Uruguay peso and Thai baht.
Performance of fund under Calich
Source: FE Analytics
The £791.7m M&G Emerging Markets Bond fund, which Calich oversees with deputy manager Charles de Quinsoas, was one the flawless funds topping the performance tables recently revealed by FE.
Not only the fund is recommended by the FE Invest team but also holds the maximum number of FE Crowns and has been top quartile over three and five years.
Over the time Calich has overseen the portfolio, the fund has grown by 52.50 per cent, double the IA Global Emerging Markets Bond sector gain of 26.87 per cent, as the above chart shows.
M&G Emerging Markets Bond has an ongoing charges figure (OCF) of 0.78 per cent and is yielding 5.33 per cent.