Exposure has been cut from 25% to 15% this year through selling the likes of Venezuela and other resource-driven Latin American markets, and countries such as Poland which Brain said have already reached yield targets.
“We have enough opportunities in other markets to keep our weighting at 15% and that’s probably where we want to be for now unless the economic environment changes,” he said, before adding the caveat that the fund’s EMD exposure could fall to zero if economic growth slips further.
Brain and his team have also cut investment grade exposure in the fund from 45% down to 23% owing to the spread compression which has been ongoing for the past four years.
Whereas, momentum and spread compression have been the defining risks in fixed income in recent years, Brain singles out duration management as key going forward.
“Some of our investment grade corporate bonds have spreads that are so tight that they are quasi-government – the risk is more duration risk than it is credit risk – so you can see us selling that kind of investment and diversifying elsewhere,” he said.
“We are trying to diversify away from markets where we think interest rates can go up – so we don’t have a duration put for low duration in the US for instance where the tapering of QE can push yields higher. But we do have higher duration in other markets like Australia where they are cutting interest rates, and New Zealand which has put interest rates on hold.”
High yield support
So-called ‘safe haven’ sovereigns with positive real yields and a good credit score currently make up around 27% of the fund’s exposure, while Brain is also cautiously optimistic on high yield, which accounts for a further 22%.
“This economic environment very supportive for high yield because it has two factors in its favour,” he explained.
“As long as growth is positive but not too strong, the high yield companies don’t tend to over lever, but on the other side their cost of borrowing is quite low so they can fund themselves quite cheaply. So it is unlikely that default rates will rise in that kind of environment.”
According to Brain’s BNY Mellon colleagues at Standish, the emerging market local currency bond market now stands at around $1trn in size.
Elsewhere, there are fears that the end of the bond "party" could get violent...