Currency exposure drives emerging market-focused portfolios to the top of IMA Global Bond Sector over one year
The IMA Global Bond sector is one of the most diverse, with funds in the peer group investing across a range of developed and emerging markets worldwide. Although like-for-like comparisons between funds in the sector are difficult, over the last year one clear theme has developed – the rise of emerging market-focused funds.
Emerging market global bond vehicles fill three of the top 10 positions in the IMA peer group with gains of at least 25% over one year.
According to Morningstar, Invesco Emerging Markets Bond is the top performer over one year to 5 July, up 29% compared to a sector average increase of 14.3%.
By contrast, European global bonds funds have struggled, with the euro one of the few currencies to have fallen against sterling over the past 12 months. Three of the bottom 10 funds in the sector are European global bond funds.
The worst performer over one year is Renfield Euro Government Bond, down 1.1%.
M&G has five funds in the sector. Launched in September 1999, Mike Riddell’s £15.89m Emerging Markets Bond is top quartile over five years, three years and one year, up 56.7%, 55.2% and 21% respectively.
Riddell says to understand why the fund has outperformed over the last year it is important to look at what has happened in markets.
“With the global bond sector, ultimately currency is what you are buying,” he says.
“Funds in the global bond sector have to own a certain amount outside sterling, and sterling has been one of the weakest currencies in the world over the last 12 months.”
Riddell continues: “Sterling has fallen 20% compared to the Japanese yen, and, most
importantly, versus the US dollar it has fallen almost 10% as well, and a lot of the funds in this sector invest in assets in US dollars.”
Most of M&G Emerging Markets Bond is denominated in US dollars. In addition, Riddell says, the majority of it invests in hard currency emerging market bonds.
“These are bonds issued by the likes of Columbia, Brazil and Mexico but they are denominated in US dollars,” he says.
The fund has also benefitted from its exposure to emerging market currencies, many of which have performed well over the last 12 months.
“The Malaysian ringgit is up 20% and the Brazilian real is up 18% versus sterling,” Riddell says.
“The Korean won is up about 14% versus sterling. So these are the themes that really drive performance.”
The fund also gained from Riddell’s move into risk assets in the middle of last year.
He says: “In 2008, we had about 10% in US Treasuries. We sold this down by buying risk and as the credit rally occurred, that certainly helped performance.”
Over the past nine months, he has been adding to emerging market currency bonds.
“Historically, the fund was only in US dollars and a bit in euros,” Riddell explains. “Now we have about 20% in emerging market currencies, such as the Mexican peso and the Korean won. We also have about 5% in the Malaysian ringgit and the Brazilian real.”
Peter Eerdmans’ £857m Investec Emerging Market Debt fund is ranked sixth in the sector over one year, up 25%.
The manager attributes much of the fund’s strong recent performance to the level of diversification in the portfolio.
“We do not like to bet the house on one or two views,” he says.
“We have lots of long/shorts across countries and currencies relative to the benchmark, which have helped performance.”
One view that has paid off is his decision to go long Asian currencies.
“We bought a lot of these around October and November last year and took profits in April,” Eerdmans says.
“More recently we have been short the Romanian leu and the Hungarian forint, which has also done well,” he adds.
On the bond side, the manager has been long duration, which he says was an accurate call.
He says: “People have been surprised by how well behaved inflation has been, and being long duration has been the right move.
“We have played it in various countries where we have seen big moves, such as Turkey, Mexico, Indonesia and Hungary.”
Local emerging markets have held up well relative to other global bond markets, Eerdmans says, with contributions from currency depreciation and bond yield compression over the last year.
“We have seen a lot of flows away from developed markets and into emerging markets,” he says.
“The fundamentals have looked so strong across emerging markets, and this has underpinned these markets as well.”
GLG’s Global Corporate Bond is ranked ninth in the sector over 12 months, up 21.9%.
Manager Christophe Akel believes the main driver behind returns has been the portfolio’s overweight to financials.
He says. “We believe in a circular story in financials, and there will be changes in banking regulations across the world, which will protect bond holders in future.”
Akel points to the reform bill due to be passed in the US, plus the Basel III and bank stress tests in Europe, as examples of stronger future regulation in the sector.
He sticks to defensive banks within financials, saying: “We do not want to be heroes.
“We have been able to get a 10% yield on good-quality banks, which is very decent in the current environment with low interest rates in general.
The fund uses the Merrill Lynch Global Bond index as a benchmark, which has a 50% allocation to financials.
“We have been consistently overweight the benchmark in the last nine months, “ Akel says.
“We see more value in the lower part of the capital structure because of all those potential tenders over time with the change in regulations.”
He is underweight AA- and A-rated bonds compared to his benchmark, but is overweight BBB because he does not believe there will be a double-dip recession.
“The balance sheets of investment grade corporates right now are very solid and stable,” he says.
The manager is underweight healthcare and energy because he feels spreads have become too tight in these sectors.
He says: “We are not concerned about their credit quality. We are just concerned about valuation because those sectors are trading around 100 bp over, which are most of the time tighter than their own sovereign risk.
“This is also a concern for us to be long these very tight spreads because we are seeing a wave of M&A, which will probably put pressure on the spreads of those very tight names.”
