The asset class is caught in a general bear market for bonds. The GBI-EM Global Diversified Index, the leading benchmark for emerging market bonds, continued its downward trend and closed the first quarter of 2022 with a loss of 4.4 percent measured in euros. In this difficult market, it is Man GLG that has been the best performer this year.
The GBI-EM Global Diversified Index, the leading benchmark for emerging market bonds, continued its downward trend and closed the first quarter of 2022 with a loss of 4.4 percent measured in euros. Emerging market local currency bonds recorded a loss of 1.8 percent in euros last year (the loss increased to 8.8 percent measured in USD).
Unlike last year, however, performance in the first three months of this year was better than the 8 percent loss of the JPM EMBI Global Diversified Index, which tracks emerging market bonds denominated in hard currency. The latter gives investors more exposure to credit risks, which have increased sharply following the war in Ukraine.
Besides concerns about slowing growth in emerging countries, emerging market bonds are also sharing in the general malaise in global bond markets due to rising inflation. For example, the Bloomberg Global Aggregate Index lost 4.1 percent of its value in the first quarter, while the Bloomberg Euro Aggregate Bond Index lost 5.4 percent.
Inflation effects
Inflation does not affect all countries in the same way. In particular, emerging markets are often more vulnerable to inflation shocks than more developed economies. Inflation comes in various forms, but today rising commodity prices in particular are receiving a lot of attention from investors.
An emerging economy that exports commodities initially benefits from this, but at the same time the increase in revenues will stimulate the economy and push up core inflation. (Energy and food prices are not part of core inflation).
For an importing country, an increase is likely to lead to more inflation in the short term followed by a fall in economic activity which, in turn, will reduce core inflation. The central banks of these countries are therefore more likely to be forced to raise interest rates to curb inflationary expectations and limit capital outflows. After all, investors in these countries know that holding local currency in such a scenario means a loss of purchasing power. Often, this only comes to an end when interest rates are high enough to compensate investors for currency devaluations.
Country selection
The question is when inflation will peak and to what extent central banks have already normalised their monetary policy. As always, this will vary from country to country as each nation faces its own challenges and opportunities, while some are further along in the tightening cycle than others.
Latin America should be the preferred region for emerging market investors in the coming months, given the tensions in Eastern Europe and the unorthodox policies in Turkey. For instance, some investors believe Brazil is at the end of its rate hike schedule as a further tightening of monetary policy could potentially lead to recession.
Meanwhile, inflation appears to be rising much more slowly in Asia, partly because the price of rice has risen less than the price of wheat. As a result, Asian central banks have recently kept policy rates mostly unchanged.
More focus on ESG
It is clear that macro factors remain the main driver for the asset class and, as always, investors will have to weigh up what is already factored into the price.
But emerging markets may eventually face headwinds from a different quarter. Investors today are more focused than before on meeting certain environmental, social and policy objectives. While the focus in recent years has been more on the climate, Russia’s invasion of Ukraine has caused investors to increasingly ask themselves what to do with investments in countries with authoritarian regimes (without having a conclusive definition). Should this materialise, the list of investable markets could suddenly shrink.
Man GLG takes the lead
For this week’s Top 5, we look at the best-performing funds investing in emerging market local currency bonds over the first three months of 2022, as measured per the distribution fee-free fund class available in the Netherlands.
In first place is Man GLG Global Emerging Markets Local Currency Rates which has been managed by Guillermo Osses, Jose Wynne and Ehsan Bashi since its launch in June 2016. Osses is head of EMD strategies at Man GLG and previously worked for HSBC Asset Management, PIMCO and Deutsche Bank, among others.
At the end of March 2022, the fund was underweight in longer-dated government bonds (7 years or more) with more than 30 percent of the portfolio in bonds with less than 1 year to maturity. The lower duration contributed to the outperformance in the past quarter. The top 10 positions account for more than 65% of the total portfolio and consist of bonds issued by various emerging countries such as Mexico (12.6%), the Czech Republic (11.8%) and Indonesia (8.7%).
Further down our list is Templeton Emerging Markets Bond with Michael Hasenstab and Calvin Ho at the helm. Hasenstab has been managing this fund since June 2002 and is also CIO for Templeton Global Macro where he is responsible for country analyses, among other things. The two managers can count on the support of five analysts with a long track record. Still, Morningstar has some concerns about the investment process. Although based on rigorous research, Hasenstab’s strong conviction and contrarian investment style is, in our view, less effective when applied to a narrower investment universe such as EMD. The fund is assigned a Neutral rating by Morningstar analysts.
Thomas De Fauw is a manager research analyst at Morningstar. Morningstar analyses and rates investment funds based on quantitative and qualitative research. Morningstar is one of Investment Officer’s knowledge partners and ranks five investment funds or providers each week.
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