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US rate hikes ‘boost EM debt appeal’

US dollar currency speculation has led one fund selector to increase their allocation towards emerging market debt

Dollar beats sterling as money market funds start 2018 strongly


Jassmyn Goh

Emerging market government bonds are now back in favour among European fund selectors. The asset class suffered a dip in sentiment in Q2 this year but has bounced back in popularity.

So-called “EM govvies” were the 6th most popular asset class (out of 26) in Q3 – a sizable leap from the 20th most popular asset class in Q2, according to Last Word Research.

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Source: Last Word Research

Of the pan-European fund selectors surveyed, 28% were looking to increase their allocations towards the asset class over the 12 months to September 2019, 35% to hold, 17% to decrease, and 20% do not use the asset class.

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Source: Last Word Research

PWM Asset Management chief economist, Mahnoosh Mirghaemi, told Expert Investor that prior to Q3 she had not invested in emerging market government debt as she expected the US dollar to keep strengthening but now this had changed.

“A stronger dollar would punish emerging markets because of the currency intervention,” she said.

“But I think the dollar will weaken within the next couple of months and this will give emerging market currencies a breather.”

So far this year, the US Federal Reserve has raised its interest rates three times to a range of 2% to 2.25%, which Mirghaemi said had already priced in the currency.

However, Mirghaemi said she was not looking at emerging markets as a whole but would “cherry pick” countries.

She said her top EM government bond to invest in was Mexico because the renamed Nafta, USMCA, would boost the country.

According to Bloomberg, the Mexican government bond 10-year yield is at its highest for at least five years at 8.13%.

Mexico government bond 10-year yield five years to 12 October 2018

Source: Bloomberg

EM govt bonds worth investing in

Brazilian debt was also a top pick for the economist has it had produced solid returns over the last month, but she remained cautious about the political situation.

“It is not a matter of who will win the presidential election but it’s a matter of who will come with a concrete economic plan and financial plan for the country,” she said.

Mirghaemi added that Vietnam equities had been doing “amazingly well” which had negatively impacted Vietnamese bond markets. “However, I don’t think [Vietnamese] equities can continue like that and therefore [Vietnamese] bonds will become attractive,” she said.

According to FE Analytics, the MSCI Vietnam index has returned 36.7% over the year to 30 September 2018.

On Argentina, Mirghaemi pointed to the country’s 60% interest rate and said even though it was risky Argentine debt could still be great investment over the longer term.

Mirghaemi said the situation in Argentina could only get better after the recent turmoil and in light of the generous yields available on government bonds it was still worth considering.

Mirghaemi said she would be monitoring the interactions between the US and China and Russia.

“Chinese bonds have great returns… as long as they can withstand the trade war with the US,” she said.

The political challenge

Mirghaemi said political risks aside, emerging markets remained undervalued in comparison to the US which was overvalued.

“So many products in the US are sourced from emerging markets which means people should be looking towards these countries to invest in,” she said.

Mirghaemi noted that to cherry pick emerging markets, fund selectors should first look at the political issues of the country, the country’s central bank involvement, and how the country is affected by fluctuations in the oil price.

Top EM debt funds

According to FE Analytics, for the three years to 30 September 2018, the top performing EM government bond fund was Bradcesco’s Brazilian Fixed Income R fund at 34.8%.

Despite this result, over the year to 30 September 2018, the fund was the second worst performing fund at -18.3%.

Edmond de Rothschild Emerging Credit A fund came second of the three years at 31.1%, followed by Aberdeen Global Frontier Markets Bond X Accumulation at 24.1%, NN Frontier Markets Debt Hard Currency I Cap at 22.8%, and Barings Emerging Markets Sovereign Debt Tranche A Accumulation at 21.8%.

All funds beat the sector average of 7.7% within the FCA Recognised universe and 6.7% within the Offshore Mutual universe.

The funds also beat the FTSE Global Emerging Markets US Dollar Government Bond index that returned 12.9% over the same three-year period.

Top five emerging market debt funds v sector three years to September 2018

Source: FE Analytics

The top funds were found using FE Analytics that were domiciled in either Luxembourg or Ireland and were within the FCA Recognised or Offshore Mutual universes and were available for sale in at least three pan-European countries.