The spate of activity seen in the emerging market debt sector in recent months has been extraordinary even for this fickle industry. BlackRock has poached a whole team of EMD specialists from BNP Paribas and Threadneedle’s head of emerging market debt, Richard House left to join Standard Life Investments, along with two of his former colleagues, to spearhead a new proposition there.
Barings, Schroders and JPMorgan Asset Manage¬ment have also been getting in on the act, with appointments of varying seniority in the sector, albeit under different guises, such as Barings’ hire of a head of Asian debt.
Such a game of musical chairs can be unsettling for fund buyers, who may perform due diligence on a certain fund with a certain team or manager running it, and then have to think again when the manager leaves and somebody else takes over.
Partly because of this, Peter Lowman, chief investment officer at Investment Quorum, says the fund and team that have made it into his firm’s IQ Centurion, or ‘buy list’, in the EMD space is Investec’s.
“Investec has a strong team of analysts and fund managers that have interesting products, which it seems to be able to keep. It is from an emerging market background [South Africa] and at the moment we look predominantly to this firm if we want to venture into EMD markets.”
While other firms have interesting propositions and, given recent manager movements, warrant another look, for Lowman it is worth sitting on the sidelines for a while to see how new teams “bed down”.
Guillermo Osses, head of EMD portfolio management at HSBC, explains: “With emerging market economies, most asset managers only started looking at them ten to 15 years ago, and most only started to manage local currency denominated mandates in a strategic way four or five years ago.
“There are a lot of people who have worked in these countries and have had experience on the sell side, but it is not easy to find people who have experience running emerging market assets strategically.
“That is why we have seen people moving around. Asset managers are trying to hire the know-how in a single swipe, rather than attempting to build the products from scratch.
“It is difficult to build an emerging market operation from scratch because you will never be able to compete with the managers who have track records.”
This personnel bolstering on the part of fund houses does not come without rationale, either. Since the start of the year, emerging market bond funds have seen inflows of close to $20bn (as at end of April), according to EPFR Global.
Granted, this flux of money has coincided with inflows of $190bn into all EPFR Global-tracked bond funds in the first half of the year, but EMD’s growth in assets should not be sniffed at, particularly since AUM in the sector have jumped more than $100bn to a total of $106bn in less than three years.
It is hard to tell exactly what has prompted such interest in the asset class, although it is safe to say the majority of money has been flowing from institutional investors, so far.
The most likely scenario is that a combination of push and pull factors has led investors to pay attention to emerging market debt, not least the scarcity of yield in more traditional fixed income go-tos.
Regardless of whether developed market bonds truly offer a safe haven or not, ten-year bunds, treasuries and gilts have all recently posted record-low yields, driven south by investors in search of somewhere ‘low risk’ to park their cash.
Combine this with higher-than-target inflation in these economies, and their sovereign debt actually represents a negative return, or erosion of capital.
Lowman says: “At some stage I assume people will try to disassemble their positions in these three asset classes and move into better yields. In that case, you have got corporate bonds, high yield, or, looking further afield, emerging market debt.”
In addition to the better yields on offer, Lowman says emerging debt markets are set to benefit from stronger or appreciating currencies and upgrades from credit rating agencies.
“You would not have touched this stuff with a barge pole going back 20 to 30 years”, he says.
The low debt-to-GDP ratios, and in some cases current account surpluses of emerging market nations, have certainly given rating agencies some food for thought.
Indonesia’s re-rating to investment grade by both Fitch and Moody’s earlier this year has been one of the more documented cases.
But Brazil, Turkey and the Philippines have also won rating upgrades in recent months, as their authorities’ fiscal and monetary policies are seen in an increasingly positive light.
There is still a way to go before what some view as an unfair disparity between the credit ratings of developed and emerging market bonds is erased, however.
Given the upheaval in the eurozone, it is somewhat surprising that Spanish debt still earns an A3 rating from Moody’s and a BBB+ by Standard & Poor’s. Meanwhile the Philippines, which can now borrow at similar rates to the fourth-largest economy in Europe, is rated as Ba2 by Moody’s and BB+ by Standard & Poor’s.
Rating agencies are still lagging investors’ views on the risk associated with emerging market debt versus developed market debt, which some would say is all the more reason to get into the asset class early.
But Peter Sleep, senior portfolio manager at Seven Investment Management, cautions against over-optimism towards the asset class: “All the politics are local, and when authorities are under pressure, the first people they stick two fingers up at are foreign debtors.”
Sleep cites the work of Carmen Reinhart and Kenneth Rogoff, ‘This Time Is Different: Eight Centuries Of Financial Folly’: “Reinhart and Rogoff mention in their book that emerging markets tend to default serially, and very few manage to make the transition from regular defaulters to making every effort to pay. The French and Spanish [ironically] are quoted as two countries that did make that transition.
“They showed that while countries with a higher propensity to pay their debt will make every effort to pay it off almost regardless of its level [developed markets], emerging market countries will default at much lower levels of debt to GDP, levels of about 40% to 60%.”
In defence of his asset class, Brett Diment, head of emerging market debt at Aberdeen Asset Management, says: “The difference is emerging market debt investors are used to thinking about sovereign defaults and pricing them in.
“Developed market sovereigns have defaulted in the past but investors are not pricing that in at all.”
He says you need a manager that can invest across the spectrum and who has a flexible mandate.
This should also help hedge against the threat of rising yields on US treasuries, which he admits would have a knock-on effect on the yields of some dollar-denominated emerging market bonds, posing a capital risk for investors.
Given the stagnant state of much of the developed world and the burnt fingers investors have received from putting too much into emerging market equities, an alternative offered by emerging market debt is understandably attractive.
Next up, expect to see an onslaught of new products managed by the specialists who have been moving around in the past few months.
Just make sure the pull is as strong as the push when it comes to allocating to the asset class.