Top 5 Emerging Market Debt funds: NNIP in the lead

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Funds investing in emerging market bonds lost for the third quarter in a row when measured in dollars, but made a small gain in euros.

Local currency emerging market bonds rose 1.7 per cent in the past third quarter after losses of 2.8 per cent and 4.4 per cent in the second and first quarters of 2022, respectively. The JPMorgan GBI-EM Global Diversified showed a year-to-date loss of 5.5 per cent in euro terms as of end-September 2022, significantly outperforming hard currency emerging market bonds as measured by the JPMorgan EMBI Global Diversified which were down 11.7 per cent. This was partly due to the stability of local currencies in those countries where central banks have already implemented several rate hikes, even before the Fed intervened.

Trouble spots

Emerging markets are a heterogeneous group, with a number of emerging economies teetering under increasing pressure from rising energy and food costs and a stronger US dollar.

Sri Lanka soon ran into trouble and eventually, then-president Rajapaksa had to flee his country. He mailed his resignation from Singapore while crowds stormed his palace in Colombo. Although this stopped the aggression, the economic problems were far from over. The corona pandemic not only caused human suffering but also led to higher debts and less economic activity to repay them. Today, high inflation and fears of a global recession add to this.

China’s role

The economic crisis is not limited to Sri Lanka alone. China, which provides loans to many developing countries like Sri Lanka and Pakistan, is facing a foreign debt crisis for the first time. China’s Belt and Road Initiative faced more defaults this year as many of the projects it finances are underperforming and infrastructure loans increase financial pressure on vulnerable governments. Moreover, when the debt mountain is unsustainable, China is often forced to issue new loans to avoid derailing the situation altogether.

Many countries are in a stronger position

In previous crises, a strengthening dollar caused problems because so many emerging countries borrowed in dollars and other foreign currencies but today the situation is different for a lot of nations. India and Brazil, for example, now borrow mostly in local currencies, with much of that debt held by local investors, making them less vulnerable to exchange rate changes.

Brazil’s central bank kept the policy rate unchanged at 13.75% at the end of last month. It was one of the first central banks to start raising interest rates in the first quarter of 2021 and that quick and aggressive approach is starting to pay off. The Brazilian real rose 5.6 per cent against the dollar this year (21.3 per cent against the euro), the MSCI Brazil stock index rose as much as 39.7 per cent in euro terms and economic data are starting to improve. The 10-year interest rate is now fluctuating just below 12 per cent, down from 13.7 per cent in July. (figures as at Tuesday 18 October)

Top-5

For this week’s Top-5, we look at the best-performing funds investing in emerging market local currency bonds over the first nine months of 2022 (of which a distribution fee-free fund class is available in the Netherlands).

NN (L) Emerging Market Debt (Local Currency) is still at one in our list with a year-to-date return of 4.6 per cent compared to 2.6 per cent at the end of June. Often, the remaining life of bonds in the portfolio is less than a year and that short maturity helped this strategy in the first nine months of 2022. According to Morningstar data, as of end-July, as much as 89 per cent of the portfolio was invested in bonds with a maturity of less than 1 year compared to just 6.9 per cent for the global emerging market bond - local currency Morningstar category.

The fund is managed by Marcin Adamczyk and Jaco Rouw. Marcin Adamczyk is the head of EMD at the Hague-based 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.

This strategy invests mainly in Latin American, Asian and Central and Eastern European government bonds. Incidentally, the fund can also invest in Chinese onshore debt securities through Bond Connect, a market that allows foreign investors to invest in the local Chinese bond market.

In third place is an ETF. PIMCO Emerging Markets Advantage Local Bond Index UCITS ETF seeks a return that, for fees and expenses, closely matches that of their internal index of the same name. This index tracks the performance of a GDP-weighted basket of emerging market local government bonds and currencies, with a maximum exposure of 15% per country. The country selection and their weights are determined annually and countries must have a sovereign rating of at least BB-, represent more than 0.3% of GDP and, of course, have a local capital market. Countries subject to EU or US sanctions are excluded, but the tracker still holds Russian sovereign paper today. The highest currency exposures are to India (14.9%) Brazil (14.7%), China (14.7%), Mexico (14.1%) and Indonesia (12%).

Netherlands classification:

Belgium classification:

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.