QROPS ADVICE: Investment News: Spotlight on Emerging Market Debt Funds

Lipper, the Thompson Reuters company, last week announced that a relatively new fund concept to the retail investment market has quickly become one of the most popular over recent months. Emerging Market Debt funds dethroned Corporate Bond funds as the most popular type of fixed income fund available, Corporate Bonds having held the top spot for the majority of 2009. Lipper's monthly figures for November revealed that total sales of approximately euro 28 billion were split between equity and fixed income-focussed assets, although it was Emerging Market Debt funds that stole the lions share of the latter.
Put simply, Emerging Market Debt funds (also referred to as "Emerging Market Bond" funds) can be considered as fixed interest funds with a geographic focus specific to one of the world's many emerging economies. Such funds vary in their specific mandate, although the majority hold assets in the form of local corporate bonds and/or local government gilts. Additionally, such assets are held in the local currency of the emerging market, so providing potential for returns on both bonds and currencies. This gives an element of hedging within a fund as bonds and currencies tend to react differently to changes in the economic cycle. In the year 2008, for example, many local bonds posted positive returns due to their favourable reaction to lower inflation, slower growth and central bank rate cuts, yet currencies struggled in the risk-averse environment.
The reason for the recent rise in popularity of such funds is best explained at a micro-economic level. The fall-out of the global economic crisis has meant that fewer banks have been willing to provide funding for corporate expenditure or in other words, loans. As a direct result of this, more and more corporations have been forced to raise funds through bond issues, issues which, owing to a drop in global investor sentiment, come with attractive returns. Likewise, many governments have also been forced to release attractive gilt issues in a bid to raise capital for economic expenditure, as a result of the usual income that they would normally collect by way of taxes, reducing. On the basis that emerging market economies are, as their name would suggest, the fastest growing, the ready-supply of opportunities for fund managers to invest is regularly replenished. It is these opportunities that Emerging Market Debt fund managers have been quick to seize upon. Furthermore, the likes of Asia, the Middle East and Latin America share similar characteristics in common with what many would regard as a "safe haven" economies: large trade surpluses, relatively small government debts, large export sectors and high domestic savings rates, providing firmer foundations for long-term growth.
Over the 16 years from 1993 to 30 November 2009, local emerging markets debt has returned 11.0% per annum to investors, yet with a volatility of only 9.4%. This compares to global emerging markets equities returning 6.1% with a volatility of 24.8% (source: JP Morgan/Investec Asset Management). It is no surprise therefore that the world's biggest fund managers are moving money into emerging market bonds, as they seek higher yields than the near zero interest rates of developed countries while trying to avoid volatility in other markets. A report by HSBC, released on Wednesday last week, shows the 13 largest global fund managers moved a large amount of money into high-yield or emerging market bonds during the third quarter of 2009. The fund managers, including names such as Allianz, Fidelity and Franklin Templeton, increased their emerging market bond holdings by an average of 19.4%.
"The low interest rate environment has diminished appetite for cash this quarter as investors seek stable growth in still volatile market conditions," HSBC's Australian head of global investments Charles Genocchio said. "Investors sought yield from bonds in a near zero interest environment, while selectively pursuing growth in equities in markets like Asia, which is emerging from the financial crisis faster."