One year on from COVID crash, which funds fared best?
On 20th February 2020, the fastest bear market in history began and, in just 20 days the global...
In 2020, emerging market bond funds posted modest returns of around 3% on average*. Not a bad return after such a turbulent year, but it was around half that of sterling corporate and sterling strategic bond funds.
The market falls caused by the pandemic and subsequent lockdowns had created what many investment grade bond fund managers described as the best buying opportunity of the century. And they weren’t wrong. But after a strong rally, valuations for the sterling fixed income asset classes are less compelling in 2021, so is this the year that emerging market bonds will come to the fore?
With emerging market bonds showing higher yields than the government bonds of many developed economies (three quarters of which are trading at negative yields once adjusted for inflation), the asset class has become increasingly attractive to income-hungry investors.
Assuming a global economic recovery takes hold in 2021, then the potential investment returns on offer should remain appealing.
“But investors will need to tread carefully; country and credit selection is going to be crucial as nations will face increased debt loads as they exit the pandemic,” cautioned Claudia Calich, manager of the M&G Emerging Markets Bond fund.
Emerging markets were not left out of the splurge in government borrowing during 2020, with many nations able to cut interest rates and borrow more cheaply. Many emerging nations enlarged their central banks’ remits and embarked on quantitative easing-type policies to both safeguard market liquidity and provide financing for pandemic-related spending. The International Monetary Fund, and other international financial institutions, were on hand to provide emergency funding to countries without such flexibility.
“While default rates in emerging markets may be expected to rise, we believe that opportunities that offer adequate compensation for default risk can still be found,” concludes Claudia. “In our assessment, it was also relevant that the impact of the coronavirus was felt across the globe, in both advanced and developing economies, without one area being obviously more affected than the other. Hence, many of the long-term trends that were evident before the crisis remain in place. For example, despite significant uncertainty, gross domestic product growth in 2021 and beyond is still projected to be higher in emerging markets compared to developed markets. In addition, demographics remain, given factors such as their significantly younger populations, which we believe should also support the economic growth differential in the long run.”
Other Elite Rated managers have been investing in selective emerging market bond opportunities in recent months.
Back in June last year, Dickie Hodges, manager of Nomura Global Dynamic Bond, told us why bonds from Russia and Egypt were better bets than the UK. When we caught up last month, his team told us they had taken some profits but were still keen on Russia “as you can get 6% yields on corporate debts”.
In December, Mike Scott, manager of Man GLG High Yield Opportunities, told us he had added to some emerging market areas that had “got bombed out”, namely Latin America. The fund had moved from a zero to 15% weighting during 2020, but he had also since taken some profits and reduced the overall position to around 10%.
Mike Riddell, manager of Allianz Strategic Bond, also rotated money into emerging market bonds during 2020. “We’ve been buying a lot of emerging markets bonds, but local currency, for example, South Africa, Rand denominated government bonds, the same thing for Brazil, for Mexico, for Russia, et cetera.
“Also, one of the big changes in the last few months has been the Asian economy and the Chinese economy in particular have been incredibly strong. So we thought emerging markets were a very good way to tap into the stronger Asian narrative, which we’ve had in our fund for a few months.”
Ariel Bezalel, manager of Jupiter Strategic Bond agrees that Chinese bonds look attractive. Just this week he said, “In a world where there are $17 trillion of negative yielding bonds, the old saying “in the land of the blind, the one-eyed man is king” springs to mind.
“We recently added Chinese 10-year government bonds to the strategy – with yields of 3.15% versus US Treasuries at 1.1% this represented an attractive opportunity. China’s economy is growing strongly with no sign of inflation, while it has a contracting workforce, stagnant population growth, stalling productivity growth and a credit bubble – similar to conditions in the developed world – which means that the country’s economic growth will trend lower. This all adds up to positive real yields in China looking somewhat attractive.”
Bruce Stout, manager of Murray International investment trust, has had a significant position in emerging market bonds since the ‘tamper tantrum’ in 2013, when the US central bank decided to raise rates against market expectations and caused a sell-off in the asset class and its currencies.
“Over a decade of fiscal prudence and financial orthodoxy in numerous emerging markets had pre-empted and prepared a large percentage of the asset class, both sovereign and corporate, for this inevitable occurrence,” Bruce said. “When the selling started, the fundamentals stayed strong.
“Against this backdrop, over the next 24 months, Murray International was able to build up a substantial emerging market fixed income exposure (19% of gross assets) at bond prices all well below par and at significantly discounted currency rates relative to Sterling.
“By the end of 2020 it was possible to assess just how positive and influential the five year total return contribution from emerging market bonds had been. Annualised returns of over +13% per annum in Sterling over five years to the end of 2020 even surpassed the annualised yearly total returns of the purely equity based reference index. In essence, the asset class’s contribution to Murray International’s overall investment objective had been significant.
“But what of the present and the future? Although current exposure has declined to around 13% of gross assets, the asset class still possesses numerous attractive opportunities for selective investment.
“In a world of exceptionally low bond yields and increasingly questionable credit worthiness, pricing anomalies in this less mainstream asset class still exist. It remains interesting that a current holding such as AAA rated HDFC Bank of India still trades on a yield of 6.3% for five year paper whilst a comparative bond in developed markets, such as the lower quality BBB+ rated Royal Bank of Scotland yields just 1.2% for a similar duration.
“Such relative valuation discrepancies can be still be found between many high quality companies in the emerging world and their developed market counterparts, so as long as such opportunity persists, Murray International will continue to seek to capitalise.”
*Source: FE fundinfo, total returns in sterling, calendar year 2020.