Four reasons to be optimistic about emerging market bonds
Emerging market bonds have had a pretty mixed year so far. Those that are issued in ‘hard currency’...
As we head into the summer months, the investment outlook is as mixed as the British weather. Some economies are enjoying buoyant growth as they reopen, while others are still faced with lockdowns. Inflation is high with fears it could stay that way, and geopolitical tensions remain high.
So, what are the professional investors doing in their portfolios? We asked some Elite Rated multi-asset managers for their views.
“We have a relatively constructive economic outlook as the vaccination rollout gathers pace, commented John Stopford, co-manager of Ninety One Cautious Managed fund, who has 57.5%* invested in companies shares.
“Within equities we believe the market backdrop supports a rotation towards higher yielding securities, particularly should a reasonable level of inflation transpire. Having previously had a bias towards cyclical names – those more exposed to economic growth – our equity exposure is now balanced between cyclicals and defensive companies following the strong cyclical outperformance seen year-to-date. We are also cognisant that valuations have moved a long way in the past 12 months, so a small portion of our equity exposure is hedged to protect the portfolio from market weakness.”
David Coombs, co-manager of Rathbone Strategic Growth Portfolio, is cautious going into the summer as he believes inflation fears will create volatility. “We are battening down the hatches,” he told us. “The earnings season was very good and most of the companies we own beat expectations, but because the base effect will mean high inflation over the summer, we’ve been building up our safe-haven assets.
“We took some profits and reduced our equity holdings ever-so-slightly in April, but we still have 61% in the asset class. The US is still by far our favoured market with 33% – driven more by stock opportunities than the macro backdrop. On the other hand, we are cautious on the UK as it tends to be a ‘receiver’ of inflation – as a service-led economy and importer of raw materials, we suffer from cost-push inflation. If sterling was to weaken that would be a double whammy.”
David Hambidge, co-manager Premier Miton Multi-Asset Monthly Income, has a contrasting view and favours the UK. “UK equities had a tough 2020 for many reasons, including unprecedented dividend cuts,” he said. “But, in our view, they offer excellent value compared with many global markets and in particular the US. Add to this the fact that the Brexit fog has lifted and the likelihood of a strong economic recovery, we would not be surprised to see the UK stock market return to favour with both domestic and overseas investors which should provide further support to prices.”
When it comes to bonds, David Hambidge has been avoiding long-duration fixed income assets. “Developed market government bonds have had a tough time of late with the first quarter of the year resulting in the steepest price decline for parts of the UK gilt and US treasury market for over forty years,” he said. “Meanwhile, longer duration corporate bonds have also struggled and particularly the supposedly lower risk investment grade space. Despite this, several our bond holdings have produced positive returns this year, including those that are floating rate (rather than fixed) which make up a relatively high percentage of the fund’s bond portfolio.”
Steven Andrew, manager of M&G Episode Income, has been adding to US government bonds as they have sold off. “The fund remains positioned with a neutral to slightly positive exposure to risk,” he said. “However, we feel it is appropriate to also have a meaningful holding of defensive assets to offset the possibility of a reversal in markets. Thus, we have a sizable position in long-dated US government bonds. We believe this stance gives us the ability to benefit from further gains in equity markets and scope to respond to any tactical investment opportunities that may be presented by a potential increase in volatility.
“We also invested in government bonds from Portugal after price falls caused the yield to increase substantially. The new position will help to diversify our government bond exposure while providing a yield advantage over cash and should give potential support in a ‘risk off’ environment. We also increased exposure to emerging market government bonds, taking advantage of the higher yields available by investing in bonds from Colombia, Chile and Mexico.”
David Coombs’ largest asset class holding is sovereign bonds at 15%. “That’s pretty high for us, especially when you compare it with our traditional corporate bond exposure which is just 1.5%,” he said. “We’ve been adding to Australia and Canada government bonds in particular – they are commodity economies and will help protect against inflation. Our cash holding is also quite elevated at 12%. But this gives us 25% in liquid assets to get us through the summer and hopefully invest later in the year.”
John Stopford added: “We have taken profits from our successful positioning in investment grade and high yield and recycled the cash into the emerging market debt space.” The fund currently has 18.1%* invested in emerging market local currency debt.
Richard Parfect, co-manager of VT Momentum Diversified Income, is finding other ways to invest in an inflationary environment.
“Our latest asset allocation meeting observed that relative valuations and the opportunity set within listed infrastructure investment trusts has improved,” he told us. “This situation was bolstered by recent launches by two new digital infrastructure trusts, Digital 9 Infrastructure and Cordiant Digital Infrastructure; it was further strengthened by additional capital raising by Gore Street Energy storage.
“All these trusts are addressing a critical need in the modern economy and infrastructure space whilst also enjoying relatively little competition in UK listed markets (as compared with renewable energy trusts that are greater in number and size). These trusts enjoy revenue streams that are closely aligned to inflation with sufficiently diversified counterparties that are benefitting from the accelerating use of ultra-high speed and mobile data communications. Meanwhile our biggest underweight is that of index-linked gilts as we do not own them. We feel they are expensive and offer little in terms of realistic return.”
David Coombs concluded: “We’ve also sold some gold – our weighting was about 5% and now it is 1%. Instead, our ‘diversified bucket’ is a broad spread of commodity exposure. We’ve also added some protection in the form of options, which cover about 10% of the equity portfolio. So, if markets fall, we’ll still make some money.”