Head of fixed income, Christine Johnson, said at a briefing in Hong Kong yesterday that EM sovereign bonds denominated in local currencies have performed very well in the first quarter.
“You’ve got the whole year’s expected return in the first quarter of the year,” Johnson said.
Since the US Federal Reserve scaled back its initial forecast of four rate hikes in 2016 and market analysts are suggesting one or two rate hikes this year, local currency EM sovereign bonds have been buoyed.
Additonally, in some EMs, such as India where oil imports are subsidised, low oil prices are helping the government shore up its balance sheet.
However, Johnson cautioned that some shocks may occur. "Maybe it will be US inflation getting stronger, or the Fed getting behind the curve and causing market panic." But her strategy is “don’t be afraid to trade the range".
"You’ve got the whole year’s expected return in the first quarter of the year"
She added that she will trim some exposure due to expectations of big volatility ahead. However, "if government bonds sell off significantly, I’d be happy to reinvest."
John Peta, head of emerging market debt, added that he remains positive on local currency EM sovereign bonds (he does not invest in EM corporate bonds) because some emerging markets economies appear to be rebounding.
“The positive surprises from the emerging markets are starting to come out, for example the PMI data and decent GDP growth in China,” Peta said.
Indonesia, as well, may be turning. Yield on Indonesian 10-year local currency bonds is currently about 8%, he said.
Indian bonds by comparison have been attractive to investors. But they have investment quota restrictions, which is prompting investors to have a look at Indonesian paper.
“Hopefully next year we will start to see growth expectations of some emerging countries begin to move up.”
Small economy exposure
Johnson said that the firm has adjusted its hedging method from using futures and credit default swaps to much cheaper options instead.
The CDSs are much more expensive and translate the volatility directly to the fund, she explained. Now it hedges credit exposure, which is very correlated to the equity markets, with S&P 500 options.
“It costs around 3.5 basis points to hedge 10% of the fund.”
Its emerging market fund also invests in small countries like Ghana, Sri Lanka and Serbia. Johnson explained the small size of its emerging market bond fund gives the flexibility to invest in these small countries, which are usually less accessible to larger investors.
The Old Mutual Emerging Market Debt fund, co-managed by Peta since January this year, has $146m of assets under management as of February.
For the trailing three years to end of February 2016, the firm's fund performance (-8.8%) lagged that of its benchmark, the JP Morgan EMBI Global Index (6.8%), according to the firm's factsheet.
However it beat FE's emerging markets fixed income sector index, which had a -15.8% during the same period.