Two global managers with big specialist emerging markets debt teams presented at Teik Heng Tan’s i3 (Investment Innovation Institute) fixed interest conference in Sydney last week. They were both very persuasive about the future important role of the asset class.
The i3 ‘Fixed Income, Credit & Currency Forum’ was held on June 19 and included presentations and discussions around multi-asset strategies and portfolio construction. The discussions reflected the times in which we live. Lower rates for longer are the go but what does an institutional investor do about it?
The two emerging market debt (EMD) managers were both well known to Australian investors: American Century and Franklin Templeton. They both had similar, active, styles and presented compelling cases for their chosen field of endeavour. Let’s face it, in the fixed income game the competition is currently not so strong.
Actually, EMD is not that new. It’s just that big investors are now becoming much more comfortable with it as a separate allocation. It can sit comfortably within the global fixed income portfolio or within the alternatives bucket. As an asset class, or sub-class, it has become comfortable in its own skin, as the psychologists say.
According to Marge Karner, American Century Investments V.P and senior portfolio manager, says that while a lot of Australian investors are still evaluating the asset class, some assume that it is riskier than it really is. “EMD is really a collection of sub-asset classes,” she says. “For example, you have a range in sovereigns from Chile’s A-rated bonds and Korea’s through to Zambian.” And then there’s stock-specific corporate debt.
The other speaker, Nicholas Hardingham, senior V.P. and portfolio manager of the emerging market debt opportunities team at Franklin Templeton, says that the question of which asset bucket EMD sits has tended to be passed over. In the US and Europe, he says, the allocations tend to have their own bucket. “Ten years ago [EMD] tended to be considered quasi-equities. But it’s yield capabilities and diverse nature changed that view.”
He says: “Some people also see it as sovereign debt, but pushing the envelope more [taking extra risk]. It’s actually the opposite of that. In our private sector [EM] debt allocations we don’t see a lot of low-rated corporates nor corporates in low-rated countries. And the diversification benefits are clear to see.”
In the paper he presented at the conference, Hardingham’s main points were:
- Emerging market debt is still associated with weakness when US interest rates are rising. However, over the last two decades, EM debt has been increasingly resilient to rising US rates
- Economic growth, the development of strong domestic financial markets, and the ‘de-dollarisation’ of EM economies means that EM countries and the EM bond universe are now far less correlated to what happens in the US than in the past. In fact, local currency issuance now dominates over hard-currency in EM bond markets
- At the same time, domestic consumption and intra-regional trade are increasingly important to EM economies. Also, the middle classes of these countries have expanded, raising savings rates and lifting economic growth, and
- Trump’s trade war with the world has served to strengthen the links among EMs. China, for example, was the biggest buyer of US soybeans, but now turns to Brazil to ensure its supplies.
Hardingham is based in London and Karner in New York. Both run active absolute return portfolios but there are subtle differences between the two firms in the asset class. Karner launched the EMD strategy for American Century when she joined the firm in 2014. She has a long background in the field, including 12 years at the World Bank’s International Finance Corporation. American Century has been coming to Australia with its EMD strategy for a long time. It’s first client, Zurich, which came on board in 2009, remains a client. There’s about A$2 billion invested in two separate strategies from Australia. Franklin Templeton, which has a much larger presence in Australia and New Zealand, across a full range of strategies, is yet to sign up a client for EMD.
Karner says: “We promise our investors a better performance contour over the long term… This asset class offers better yield, often with a better credit quality, than in the developed markets. The country comparison in the equity world is quite different than the debt world.”
With emerging market equities, she says, the allocation tends to be 70 per cent Asia. But with EMD it is more like 30 per cent central and south America, 30 per cent Asia and the rest emerging Europe, Middle East and Africa.
“Through an Australian lens, the historical returns have been very attractive. And they have been enhance3d if you hedge out the [US] dollar… On a risk-adjusted basis it has been a better performer than most other investments.”
But it’s a complex asset class, with many moving parts, such as the whole decision -making process around currencies. This tends to scare people off.
Greg Bright is publisher of Investor Strategy News (Australia)