One area most advisers may not have considered for portfolios is emerging market debt (EMD), and tak...
One area most advisers may not have considered for portfolios is emerging market debt (EMD), and taking this a step further perhaps focusing on local currency (LC) issuance. However, this specific investment area is receiving publicity due to new fund launches over the past 12-18 months and an increasing awareness by investors of emerging markets in general.
The potential investment benefits from this investment area over the long term include real capital growth (from the debt, currency appreciation, and yield compression perspectives), attractive levels of income, and low correlation to other asset classes, therefore providing good portfolio diversification benefits.
A recent detailed review undertaken in this area provided some interesting talking points and many important characteristics advisers should be aware of.
One of the initial obstacles advisers will need to approach is the perceived risk of investing in LC EMD, balancing this with the potential reward. Many advisers will think it to be more volatile than investing in fixed interest securities available in developed markets. This is probably true in absolute terms. However, with the credit quality of many emerging market countries increasing significantly over the last 10 years (a prime example being Brazil government debt attaining investment-grade quality in May), there has been more local debt issuance available for investors and this is continually increasing.
At this point, and for reasons touched on later with regard to fund selection, it is important to distinguish between hard currency (HC) and LC issuance. HC relates to issuance from developed countries denominated in currencies such as US dollar, euro and Japanese yen. This HC categorisation is often referred to by EMD fund managers as 'external debt'. Many emerging market countries will issue debt in these HC, the most common being the dollar, even though they have their own specific currencies too. It is not this HC we wish to focus on, as the better diversification benefits come from the LC markets.
There is limited exposure to EMD through various global bond funds, and although the flexible investment mandates of some of these funds would in theory allow 100% in EMD, in reality the managers would not go to this degree. In addition, the more diversified global bond funds are unlikely to provide the specific LC exposure. There are a few funds investing specifically in emerging market debt. However, the majority of these funds are not focused on LC, but provide exposure to HC.
There are several offshore funds worth considering focusing on sovereign issuance, including Invesco Emerging Local Currency Debt, JPM Emerging Local Currency Debt, Pictet Emerging Local Currency Debt and Schroder ISF Emerging Market Debt Absolute Return. Pictet's fund is currently the purest LC sovereign-focused fund, i.e. it typically has the least exposure to HC or credit issuance. Pictet is a definite specialist in this area, with a slightly longer track record than some of its peers, and the fund provides a 5.5% gross yield.
One final fund advisers may want to cast their eye over is the offshore Thames River High Income fund, which provides exposure to both HC and LC, and both sovereign and credit issuance. It is therefore very diversified and could provide a broader exposure for advisers, in addition to generating a gross yield of more than 7%.
- Mark Smith is a senior analyst at Andrews Gwynne LLP.
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