While emerging market (EM) debt has experienced a difficult year, the EM corporate bond market remains the most defensive segment of the EM fixed income asset class. It has comfortably outperformed other markets, such as EM sovereign hard and local currency and frontier bonds.
Fund managers continue to believe that the fundamentals of EM corporate bonds are on a solid trajectory amid the volatility. However, most have taken a defensive position in that asset class this year.
On the defensive
Citywire A-rated Colm McDonagh, who manages the BNY Mellon Emerging Mkts Corp Debt USD X fund at Insight Investment, said his fund shifted to a more defensive stance in first quarter and continued to maintain this defensive stance through second quarter.
The fund reduced its high yield exposure and duration in the first half of the year. It also increased its cash levels in anticipation of being able to take advantage of more attractively priced new issuances.
Although the fund significantly increased its exposure to high yield bonds in July and doubled its exposure to Brazil when EM corporate spreads became more attractive, it quickly reduced some of this exposure in August as trade tensions intensified again.
‘This defensive position through most of 2018, we think, is justified, limiting exposure to some of the areas of the market most impacted by both idiosyncratic and global events,’ McDonagh said.
The BNY Mellon Emerging Mkts Corp Debt USD X fund sits at the top of the EM global corporates category, with returns of 20.09% over the past three years.
The fund seeks to invest in debt of companies in EMs that are of similar or better quality than their developed counterparts, but at a more attractive valuation.
Second place goes to Amundi Asset Management’s Amundi Funds Bond Global Emerging Corporate IU (C) fund, which has returned 15.34% over the past three years, compared with the sector average of 11.71%.
Fund flows in EM debt have been more resilient this year than many had feared, and they are still in positive territory year-to-date, with around $19 billion of inflows.
‘Interestingly, we saw over $50 billion of buybacks from EM corporates year-to-date,’ said Vydrine, who is also deputy head of EM debt at Amundi Asset Management.
‘This demonstrates the strength of the balance sheets of EM companies and supports the technicals even further,’ he added.
Vydrine said his fund only invested in hard currency bonds, thereby avoiding exposure to EM foreign exchange devaluation.
At the same time, he said he keeps the duration of the fund relatively low – below four years – as this helps to position the fund quite defensively against increasing US rates.
Against the challenging backdrop, the fund has also been re-positioning towards issuers which are more fundamentally resilient to the headwinds, he added.
Citing an example, Vydrine said commodity exporters in countries like Brazil are set to withstand politics-driven Brazilian real (BRL) volatility better than more domestic-oriented issuers.
In addition, the fund has been getting more constructive on industrial issuers in Mexico lately, following a period of elevated political uncertainty.
The fund also maintains exposure within some more challenged countries, such as Turkey, which is still experiencing political and economic turmoil.
‘We did, however, rotate into the strongest issuers within the country, which have sufficient cushions to withstand macro deterioration,’ Vydrine said.
Within EM corporate bonds, countries like Indonesia, Turkey, Argentina and Russia have been some of the standout negative performers due to idiosyncratic issues, said Citywire A-rated Siddharth Dahiya.
Dahiya, who runs the AG EM Corporate Bond Z MInc USD fund at Aberdeen Asset Management as head of EM corporate debt, comes third in this category. The fund returned 20.35% over the past three years.
‘We have been positioned relatively defensively, but haven’t made any wholesale asset allocation changes, and remain holding higher than average cash in order to capture any potential dislocations,’ he said.
Dahiya said the fund’s selection in Mexico, Kazakhstan, Israel and Nigeria has been a key contributor to fund performance.
‘We are also underweight in distressed credit in Jamaica, which has been one of the key contributors towards performance,’ he added.
This article was published in the October issue of the Citywire Private Wealth magazine.