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Emerging market debt – a reversal of fortunes

Investors are fleeing from emerging market debt, and optimism for any recovery in the near term is low, particularly for local currency government bonds.


PA Europe

Many of the largest EM local currency funds deliver performance close to the JPM GBI EM Global Diversified Index, and only a select few have managed to deliver superior returns. However, Rob Drijkoningen, co-head of emerging market debt at Neuberger Berman, dismisses the suggestion of benchmark hugging, at least for his own NB Local Currency Debt Fund.

“We are very active investors, and use a lot of [currency] swaps and other active instruments that are not all visible on our factsheet,” he says. However, he points out that “in highly correlated markets it can be difficult to see the effect of active management over the short-term, but it plays out over time… in hard currency, it’s only the credit profile that matters, while cyclical and policy factors play a larger role in local currency returns.”

Ditching the benchmark

Emerging market debt is one of few asset classes where even investment-grade hard currency debt more often than not yields above 5%. This is one of the reasons Omar Gadsby, head of fixed income fund selection at Credit Suisse’s private banking arm, has been a long-standing proponent of the asset class. But he has realised there is a need to change course to keep the wind at his back.

“We must structure portfolios differently now and replace the core,” he says. “In the past our core funds were benchmarked to the JPM indices but this is no longer the case.” According to Gadsby, the problem of these benchmarks is not just that they are rather volatile. Like many fixed income indices, they are also highly concentrated. The top 10 countries in the aforementioned JPM GBI EM Global Diversified local currency index make up 88% of the market cap, and ‘problematic’ countries such as commodity exporters are well-represented.

“You can find the most value in countries with weights of less than 2% or which are even outside the benchmark,” he says. A fund Gadsby (pictured right) places in this category is the Global Evolution Frontier Markets Fund.

“This fund did relatively well last year, compared to EM local currency funds which did horribly. It was down only 1.25% in euro terms.”

While he allows his satellite positions to chase trends such as infrastructure development in India and population growth in Indonesia, his core consists of relatively high quality short-duration and total return funds.

“Short-duration funds are less sensitive to interest rates going up. They are more seasoned bonds and there’s much better visibility whether the coupon can be repaid.” One of the funds Gadsby has placed in his core is the Neuberger Berman Short Duration EM Debt Fund. Perhaps unsurprisingly, it was Neuberger Berman’s best performing EM fund last year, according to Drijkoningen.

“The fund has a combination of both sovereign and corporate names we own in our other EM debt funds. It has an unconstrained approach and a strong quality bias. The return target is Libor plus 300 basis points,” he says.