Over the past five years, the average manager in the Emerging Markets Hard Currency Debt Funds sector has returned 15%. In the next five, they may be poised to deliver double that.
That inference comes from a forecast by Jan Dehn, head of research at Ashmore Group, which subadvises the high-flying PF Emerging Markets Debt fund.
Dehn noted that US dollar-denominated emerging market government bonds offered a yield of 5.3% in December, representing a spread of almost 300 basis points over the equivalent US Treasuries. All else being equal, then, that yield alone should produce a compounded total return of 29% in the five years from 2017 to 2021.
For Dehn, though, a fairer spread for these emerging market bonds would be 200 basis points. Should the spread tighten to such a level, the capital appreciation would be worth 7%. Adding the income element, Dehn arrived at a potential total return from this sovereign emerging market debt of between 30% and 36% by 2021, depending on where the spread eventually settled.
All this should be supported, Dehn argued, by improving fundamentals for emerging market issuers: These regions should enjoy annual economic growth around three percentage points higher than developed markets through 2022, and corporate high yield default rates are even lower in emerging markets than in the US.
Ashmore’s Citywire AAA-rated team of Mark Coombs, Ricardo Xavier, Herbert Saller and Robin Forrest is second only to AAA-rated Jonathan Kelly’s Fidelity Series Emerging Markets Debt fund in this category by information ratio over the past three years. However, the Fidelity strategy is currently closed to new investors.
The price is right
Next by risk-adjusted returns for this period is the T. Rowe Price Emerging Markets Bond fund, managed by AAA-rated Michael Conelius. His portfolio’s largest overweights are to Brazil, Argentina, Ghana, Serbia and Sri Lanka at the country level, and is underweight China, the Philippines, Chile, Russia and Hungary. It is also significantly underweight investment grade issuers, preferring higher-yielding credits.
AA-rated Yong Zhu of the DuPont Capital Emerging Markets Debt fund ranks just behind Conelius over the past three years by manager ratio. Zhu has a value-based approach, blending quantitative and qualitative in-house research that includes a proprietary country-selection analytic model drawing on both economic and social screens. This has highlighted the likes of Mexico and Argentina as undervalued, with the fund overweighting these picks relative to the index.
Next in the rankings is the A-rated pair of Katherine Renfrew and Anupam Damani, who run the TIAA-CREF Emerging Markets Debt fund. Their portfolio has a 50% weighting to corporate bonds – favoring them over sovereign debt – and also has an exposure of 17% to local currency debt, where the managers view both the fundamental and technical factors as attractive. Renfrew and Damani observed that local currency bonds possess a shorter duration but higher yield than hard currency alternatives, provided the relevant currencies do not weaken substantially.
In 2017, the managers outperformed their JP Morgan Emerging Markets Bond Global Diversified benchmark by almost four percentage points, benefiting from positions in hard currency Brazilian corporate distressed situations and South African and Dominican Republic local currency sovereigns, and also from being underweight Venezuela and Chinese quasi-sovereign issuers.