With a first-half loss of 7 percent when measured in euro, the GBI-EM Global Diversified Index, the benchmark for emerging market bonds, was by no means the worst student in its class.
The past six months have been one of the toughest for bonds ever. Especially long-dated bonds have taken a beating. The Bloomberg Euro Aggregate 10+ Year index fell by no less than 23.6 percent while the Bloomberg Euro Aggregate 1-3 Year index was “only” 2.9 percent lower.
The JPMorgan EMBI Global Diversefied, the benchmark for emerging market bonds in hard currency, recorded its worst start to the year since 1994 with a loss of 13.3 percent year-to-date. In that respect, the loss for emerging market debt in local currency was not too bad. This is partly due to the stability of local currencies in those countries where central banks have made several rate hikes even before the Fed came into action.
Possible divergence within the universe
For now, higher global inflation means they will stay at this rate, but the differences between regions and countries remain interesting. For example, higher inflation in central and eastern Europe contrasts sharply with inflation in Latin America, which appears to have peaked, and that in Asia, which remains rather subdued. This suggests that we may see greater divergence in monetary policy in the near future.
But not every central banker is raising interest rates. Russia’s central bank cut its policy rate by 150 basis points to 9.5 percent last month after inflation expectations in the country fell to 14 to 17 percent in 2022 and 5 to 7 percent in 2023. Meanwhile, President Erdogan said Turkey will continue to cut interest rates. So despite the evidence that his policy is not working and skyrocketing inflation, he is refusing to change course.
Not compensated for risks
Meanwhile, in terms of performance, there seems to be no end to the agony for this asset class. The average annual return over the last ten years is a meagre 0.4 percent measured in euros versus 2.1 percent for the broad Bloomberg Global Aggregate index.
Investing in emerging market securities comes with numerous risks, including exchange rate risk. As an investor, you expect to be compensated for this over the long term, but this has not happened over the past decade.
Good years such as 2012, 2016 and 2019, when the index posted double-digit gains, alternated with loss years, leaving allocations to this asset class often tactical. In the first five months of 2022, European investors pulled more than one billion euro from the Global Emerging Market Bond-Local Currency Morningstar category, on top of the 5.1 billion euro outflow in 2021. This outflow should not come as a surprise given the growing fears of a global recession. In addition, higher yields on, for example, US government paper make emerging market bonds less attractive in relative terms.
NN(L) Emerging Market Debt (Local Currency)
For this week’s Top 5, we look at the best performing funds that invest in emerging market local currency bonds over the first six months of 2022, as measured by the distribution fee-free fund class as available in the Netherlands.
First up is NN(L) Emerging Market Debt (Local Currency). The fund is managed by Marcin Adamczyk and Jaco Rouw. Marcin Adamczyk is the head of EMD at the Hague fund house, which saw Marcelo Assalin, Marco Ruijer and nine other EMD team members leave for US-based William Blair Investment Management at the end of 2019.
Its strategy invests mainly in Latin American, Asian and Central and Eastern European government securities. The fund can also invest in Chinese onshore debt securities through the Bond Connect, a market that allows foreign investors to invest in the local Chinese bond market.
Often, the remaining life of bonds in the portfolio is less than a year and this short duration helped this strategy in the first six months of 2022. At the end of May, 58 percent of the portfolio was invested in bonds with a maturity of less than one year compared with just 6.3 percent for the global emerging market bond - local currency Morningstar category. Although this fund has finished in the first decile of its Morningstar category over the past three years, it seems to alternate between relatively strong years and weak ones.
Man GLG Global Emerging Markets Local Currency Rates
On the second rung 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. A similar story here, as the portfolio consists of more than 30 percent bonds with a duration of less than one year and is heavily underweight in 7-10 year bonds. The lower duration contributed to the outperformance of this strategy.
Thomas De Fauw is a manager research analyst at Morningstar. Morningstar analyses and evaluates investment funds on the basis of quantitative and qualitative research. Morningstar is one of Investment Officer’s knowledge partners and ranks five investment funds or providers each week.