Sébastien Unger, Senior Product Specialist for Fixed Income and Balanced Products, "Pictet-Emerging Local Currency Debt-P USD" (20.09.2011): "One of the most important factors is to assess the current economic slowdown and the impact on EM markets as the latter may imply some monetary policy changes leading to currency adjustments. Commodities are also closely followed as weaker commodity prices may impact EM currencies negatively."
Ernesto Bettoni, Investment Spezialist Emerging Markets, "BNP Paribas L1 Bond World Emerging Local C C" (20.09.2011): "They change every quarter, today they are Inflows, global growth, EU crisis, US fiscal woes and global inflation and QE type of strategies."
Ralph M. Gasser, Senior Product Specialist Fixed Income, "Julius Baer BF Local Emerging-USD B" (22.09.2011): "As indeed for virtually most segments of financial markets, global emerging markets bonds are currently – as for the last several months – not driven by fundamentals but by sentiment, which is in turn driven by political decisions concerning the western sovereign debt crisis, global and namely western growth dynamics as well as the growing stress in the banking sector. The dominance of market technicals is also reflected by the fact that recent selling has been worst in very popular (Brazil, long-end Indonesia, South Africa, Mexico or Russia) rather than vulnerable (e.g. Turkey) markets. Therefore, top-down “risk-on” or “risk-off” decisions are most important.
Fundamentally, the arguments for EM debt are unchanged. EM fundamentals - growth and debt sustainability - are locked on a much better path than the developed world are are in the aggregate generally much stronger than they were three or five years ago. This will not change in the next few years, regardless of what happens in Europe. As such, allocations to EM are likely to rise. There will be bumps on the way."
Jacob Elbækgaard Jensen, Portfolio Manager, "Jyske Invest Emerging Local Market Bonds" (20.09.2011): "Looking at Emerging Bonds we have a close look on three areas:
• Fiscal budget
• Inflation and monetary policy
• Balance of payments
These three factors are all very relevant for a country to deliver long term progress. We look at the level, but also the scope for improvement."
David Dowsett, Portfolio Manager, "BlueBay Emerging Market Local Curr Bd USD Base" (21.09.2011): "We look at a number of factors when investing in emerging market debt. Emerging market economies are growing strongly and we believe the overall fundamental improvements in emerging market economies should allow for continued growth. Meanwhile credit ratings are on an upward trajectory and we expect further rating improvements to be driven by strong economic growth and increased levels of foreign exchange reserves. Both Peru and Brazil received sovereign upgrades in July. We also believe improving fundamentals on the sovereign side could result in corporate upgrades. Investors are becoming increasingly attracted to the positive growth story as well as the higher yields offered by emerging markets issuers. This is in stark contrast to the lower yields and deteriorating fundamentals of many developed markets. Also, current market capitalisation does not match economic output and we believe this will need to grow as emerging market growth outperformance occurs. We would expect to see especially large increases in local currency and corporate debt issuance to match the liabilities of sovereigns and the high capital needs of domestic corporates looking to benefit from strong internal growth."
Hans Christian Backman, Portfolio manager and Emerging Markets strategist, "ISI Emerging Market Local Currency Bonds" (14.09.2011): "Debt/GDP, Budget surplus to GDP, Financing needs, Political enviroment (stability, reform progress, External Accounts, GDP growth, inflations and etc."
e-fundresearch: "What is your assessment of the current emerging markets bond spreads?"
Sébastien Unger, Senior Product Specialist for Fixed Income and Balanced Products, "Pictet-Emerging Local Currency Debt-P USD" (20.09.2011): "Given the current negative risk backdrop and the high political uncertainties, we became more neutral in terms of portfolio positioning and use some proxy developed trades to increase the liquidity of assets.
The recent move wider in spreads will at some point present an interesting opportunity in this asset class given that we think in a less volatile but low rates environment, spread products such as emerging usd bonds should do well."
Ernesto Bettoni, Investment Spezialist Emerging Markets, "BNP Paribas L1 Bond World Emerging Local C C" (20.09.2011): "They are extremely attractive at current levels, as they are suffering from collateral damage from the developed world. They will continue to compress over the long run to reflect the big gap in fundamentals between EM economies and the developed world. Just today we saw Italy being downgraded and Turkey being upgraded (20 Sep 2011)."
Ralph M. Gasser, Senior Product Specialist Fixed Income, "Julius Baer BF Local Emerging-USD B" (22.09.2011): "Relative to fundamentals, spreads should in our viev price at around 225-250 basis points on fair value grounds. However, the “risk off” mode of recent months has pushed spreads to around 420 basis points. Strategically, spreads are certainly good value as the positive relative credit migration trend between emerging markets and the western world remains fully intact, which should lead to significantly tighter spreads over time. Tactically, we remain rather defensive on credit risk, particularly in the EM corporate space."
Jacob Elbækgaard Jensen, Portfolio Manager, "Jyske Invest Emerging Local Market Bonds" (20.09.2011): "The Fund Emerging Local Market Bonds is in local currency only and therefore we do not have same type of spread measurements as in credit markets. But of course we compare the yield difference between the local Emerging Markets and the developed markets to evaluate the level of attractiveness for investors to be involved.
Currently we see the yield difference as attractive compared to US treasuries, but also compared to BBB credits for instance. Emerging Markets fundamentals are strong with low debt to GDP, manageable inflation and high potential growth."
David Dowsett, Portfolio Manager, "BlueBay Emerging Market Local Curr Bd USD Base" (21.09.2011): "We are remaining cautious in the short term on continued uncertainty surrounding the situation in the eurozone periphery and broader macroeconomic weakness. However, over the medium term, we believe emerging market growth prospects remain healthy and these countries should not be hit by problems in the developed world. We will look to take advantage of market weakness and believe the investment environment in the sovereign hard currency space looks attractive at a spread level of 375-400bps (as represented by the JP Morgan EMBI Global Diversified Index). While we expect continued volatility in the short term, we expect spreads could move tighter as the year progresses. In our view, there is no real change in the positive structural growth story of the asset class."
Hans Christian Backman, Portfolio manager and Emerging Markets strategist, "ISI Emerging Market Local Currency Bonds" (14.09.2011): "High compared to average credit rating. High vs. developed countries if you look at Debt/GDP, Budget surplus to GDP, Financing needs, GDP growth and demographics."
Question 3
e-fundresearch: "Which are the most important elements in your investment process?"
Sébastien Unger, Senior Product Specialist for Fixed Income and Balanced Products, "Pictet-Emerging Local Currency Debt-P USD" (20.09.2011): "The most important element of our process is that we have a 2 stages process:
Stage 1 which enables us to assess the global temperature for taking risk and sets the tone for our country selection. In the second step and once a country is selected, the currency and the interest rates of that country are examined independently."
Ernesto Bettoni, Investment Spezialist Emerging Markets, "BNP Paribas L1 Bond World Emerging Local C C" (20.09.2011): "We have a qualitative investment philosophy where the quality of information and ownership of convictions gives us an edge in EM. We do not want our investments keep any secrets from us: an inquisitive approach and a “backpacking” style will enable us to generate superior returns. We also use proprietary fundamental research and quantitative tools as a starting point to feed our qualitative approach. We also use a Proprietary “Global Weather Station” which is a decision making tool that enables us to assess the speed of numerous global drivers affecting EM at the same time but with different intensities and consequences."
Ralph M. Gasser, Senior Product Specialist Fixed Income, "Julius Baer BF Local Emerging-USD B" (22.09.2011): "Our investment process combines top-down and bottom-up factors as well as fundamental, quantitative and market technical considerations.
These considerations drive our decision if we aim to invest in a local market or not, and if so, over which time horizon (strategically or tactically), to which degree (index neutral, underweight, overweight, or out-of-index), in which performance dimension (currency and/or yield curve and/or local credit), and through which instrument. It also drives how aggressively or defensively we aim to be positioned in the aggregate as well as in which performance dimension of the overall portfolio.
Crisis Avoidance
The first step in the Investment Process is to filter out those markets we judge to be at risk of crisis. We do this on the basis of a system developed internally.
The framework of this system is that Emerging Market crises have a variety of drivers – public and private sector debt crises, inflationary episodes, policy mismanagement. Obvious indicators – especially market indicators such as exchange or interest rates fail to pick out the problems but every crisis has shown some of the following group of indicators showing signs of disequilibrium:
- Falling foreign exchange reserves
- Falling ratio of fx reserves to broad money
- Zero or negative real interest rates (forward basis)
- Rapidly rising inflation
- Rapid rise in Credit/GDP ratio
- High & Rising Current Account/Exports of Goods and Services
- Uncompetitive exchange rate (Import/Export growth strongly positive)
- (Qualitative) Vulnerable banking sector to external shocks
- (Qualitative) Rapid deterioration in fiscal position.
Overall these indicators generally will highlight when a market is either accumulating increased vulnerability to a change of sentiment from domestic or foreign investors, or that such a change in sentiment is in fact occurring.
We will generally avoid countries scoring three or more negatives on this checklist. We would regard five or more as a red flag.
Country & Instrument Selection
Our investment philosophy has the duration decision secondary to the currency decision – we generally do not hold hedged bonds as both from an empirical and theoretical point of view this is not a successful strategy. Overall we regard long duration as an opportunistic strategy for adding alpha to the portfolio. Bond markets are more dependent on more reliably forecastable factors such as interest rates, but generally do not add material diversification to a currency strategy (bonds don’t rally in a market where the currency is weak).To increase risk more generally we will generally increase currency exposure. In short, currencies for beta, bonds for alpha.
Interest rate and currency risks are assessed using extensive in-depth fundamental research also incorporating quantitative (relative) as well as market technical (e.g. direct or related investment flows) considerations as illustrated below. For instance, we extensively evaluate international and domestic economic, political and market developments, global and local tactical and strategic capital and investment flows, liquidity, risk appetite and volatility, domestic debt scheduling and flexibility as well as international and local demand dynamics for local debt, international capital flows and pricing patterns in related investment fields such as commodities and emerging markets equities, but also stress test scenarios like liquidity crunches and global spill-over effects.
In addition to the extensive in-depth analytical work we conduct, we also interact closely with local government representatives, policymakers and consultants. Team members also undertake regular visits to all relevant countries. While the vast majority of research is conducted in-house, we also source complementary information from external sources, such as supranational organisations, brokers or the rating agencies.
More specifically, we use a matrix to assess the 23 deep and (relatively) liquid local markets we assess on a regular basis, and run a similar assessment on other markets we may wish to assess on an ad hoc basis. We assess each currency in terms of 14 indicators covering the state and dynamics of the external balance of payments, the stability of domestic monetary developments, the level of real interest rates and the likely path of interest rates.
Some indicators will be normalised to allow for cross-market comparison (for example to make growth in FX reserves in US$ terms comparable across countries. Some indicators may be forecast by the investment team.
We then rank the markets we examine on the basis of these 14 indicators and allocate under- and overweightings of markets on the basis of the rankings. The actual scale of the weightings is purely qualitative on the basis of the managers’ assessments – and often subject to feedback from the Risk Management stage of the Investment Process (see below). We have investigated attempting to produce more formal model output – a more quantitative allocation approach – and found this deeply unsatisfactory, because of the risk of excessive concentration of risks in country allocations and because of the difficulty of factoring in the (very important) top-down view of the global economy.
Duration Risk
Having established currency allocations, the fund makes a decision of what duration to hold in the markets to which allocations are made. The framework used for this assessment is basically the same as that used for duration allocations – one of “mean reversion” globally in yield curve steepness and real interest rates. By systematically allocating to markets with the highest real interest rates and steepest curves and staying out of markets with low real interest rates and inverted curves, we expect to produce superior returns. At its simplest “steep curves flatten, flat curves steepen”.
The threshold for an acceptable level of curve steepness or real interest rates is determined by the global environment.
Security selection
Once we have defined from a top-down perspective if we aim to invest in a local market, over which time horizon (strategically or tactically), to which degree (index neutral, underweight, overweight, or out-of-index), and in which performance dimension (currency and/or yield curve and/or local credit), we select the most efficient instrument to reflect our view. For instance;
- if we aim to take exposure towards the local yield curve, local currency and local credit, we will typically select debt instruments – if available – issued by local governments, agencies or corporates denominated in the local currency.
- If we aim to take exposure towards the local yield curve and the local currency but not towards local credit, we will typically select debt instruments – if available – issued by organizations or western financial institutions denominated in the local currency and/or linked to the local currency and/or local credit. Where such bonds are not available, we will synthetically replicate such exposure through longer-dated FX forward contracts.
- If we aim to take exposure principally towards the local currency but not towards the local yield curve and the local credit, we will typically use FX forward contracts. FX forward contracts and FX derivatives are also applied for hedging purposes, usually on a tactical basis.
In evaluating debt instruments, we will also consider local and international ownership, current and future supply and demand dynamics, current and future market liquidity, broker inventories and bid/offer pricing patterns, as well as security specifics, such as:
- Interest duration
- spread duration,
- basis points – value (BVBP)
- spread BVBP
- convexity
- legal covenants
- linkage and/or
- collateral.
Corporate Credit Risk
Corporate Credit Risk has not been an important driver of the investment process in recent years as we felt credit spreads did not provide sufficient compensation for the lower liquidity of instruments and the lack of visibility at the issuer level. Generally local currency corporate debt is neither a large nor a growing market (corporates prefer to borrow in US$ and hedge) so we see this as a useful but minor source of potential alpha. More broadly, we hold no more than 10% of the fund in potentially illiquid securities (securities where a short-notice liquidation is likely to incur a material discount)."
Jacob Elbækgaard Jensen, Portfolio Manager, "Jyske Invest Emerging Local Market Bonds" (20.09.2011): "Our investment process is very much focused on macro development. We have a monthly macro and strategy meeting in the Jyske Invest Fixed Income team. This gives us a top down approach. Given this scenario, we screen the GEM universe for investment opportunities that suits the current situation. We use in-house developed quant models for this screening purpose, as well as external ideas."
David Dowsett, Portfolio Manager, "BlueBay Emerging Market Local Curr Bd USD Base" (21.09.2011): "We are active managers and have a dynamic, research-driven approach which draws upon both top-down and bottom-up inputs. As part of our focus on absolute returns, both our long-only and long/short products use short positions (typically via FX, IRS or CDS) as one of a number of techniques designed to deliver absolute-style returns. We also have a strong emphasis on capital preservation and the use of derivatives helps us to maximise portfolio efficiency and minimise risk."
Hans Christian Backman, Portfolio manager and Emerging Markets strategist, "ISI Emerging Market Local Currency Bonds" (14.09.2011): "The global nature of emerging markets provides an unlimited range of investment opportunities. We believe that financial markets are efficient in the long term. However, in the short term, informational, quantitative and behavioural inefficiencies within financial assets, countries and regions can cause prices to deviate significantly from fundamental value, thus offering an opportunity to be recognized and exploited by active investment management.
Our ideas are generated through a team based integrated investment approach, where portfolio construction starts with a top-down macro economic risk assessment and ends with an in-depth bottom-up fundamental value analysis on credit and FX.
We employ a multitude of complementary skills and proprietary models to identify changes in investor sentiment/psychology and catalysts that can trigger asset re-pricing. Through this integrated analysis we identify value investments and express these through both directional and relative value positions."
Question 4
e-fundresearch: "Which over- and underweight positions are currently implemented in global emerging markets bond funds? How large is the weighting in corporate bonds and local currencies?"
Sébastien Unger, Senior Product Specialist for Fixed Income and Balanced Products, "Pictet-Emerging Local Currency Debt-P USD" (20.09.2011):
"In terms of non government exposure, 1.92% was invested in corporates and 2.80% in quasi-sovereign issuers."
Ernesto Bettoni, Investment Spezialist Emerging Markets, "BNP Paribas L1 Bond World Emerging Local C C" (20.09.2011): "We prefer to assess both asset classes separately. In the local side, 95% is in government bonds and we use local corporates tactically. We also have a fully dedicated strategy for EM corporate bonds in hard currency. We like local debt a lot over the long term, and believe that portfolios should have an overweight in EM local debt. For the next couple of months we like the short part of the curve in Indonesia and South Africa. In he currency side we like the Kazakhstan Tenge in the Colombian Peso."
Ralph M. Gasser, Senior Product Specialist Fixed Income, "Julius Baer BF Local Emerging-USD B" (22.09.2011): "• We maintain our constructive stance on the asset class and stay – accordingly – fully invested in the EM FX space with a strong bias towards Asia and LatAm while also keeping our overall mild o/w stance towards EM Credit, both in line with our long-standing strategic preferences. In turn, we still favour moderate EM Rates sensitivity across the majority of markets but continue to gradually add to nominal duration namely in LatAm but also increasingly in Asia
• For the month, we left the fund’s modified duration largely unchanged at 4.9 years (+0.1 years m/m). At the single market level, however, we added exposure and/or overall duration in Mexico, Malaysia and Hungary through mid- to longer-dated paper mainly at the expense of equivalent exposure in Turkey and S Africa. Despite the selective addition of nominal paper we still maintain a substantial exposure towards CPI-linkers (21% of all bonds held) centred upon Brazil, Uruguay, Turkey, Mexico, S Korea, Poland, S Africa, Chile and Thailand both for value and hedging
• In the aggregate, the fund’s main marginal rates exposures are run in Mexico (mDur 6.2yrs); Brazil (3.9yrs); Indonesia (6.9yrs); S Africa (6.2yrs); Hungary (3.7yrs); Chile (3.7yrs), Uruguay (7.4yrs); Peru (8.4yrs) and Poland (3.7yrs). The fund’s YTM stands at 6.4% or a marked +3.7% in excess of implied BM levels
• In the FX space, we continued – as for the past 6 months – to rotate out of C&EE/ME&A into Asian/LatAm FX thereby further emphasising our pronounced relative value stance. Main FX positions are:
• HKD (18.8%; +8.7% o/w): HKD traditionally very tightly managed vs. USD (= USD-proxy) but potential for one-off spot price revaluation (= “free call option” vs. fund reference currency); 10% representation in fund BM
• MXN (13.1%; +3.5% o/w): Comparatively steep nominal/real yield curve set to flatten with hiking cycle completed amid benign CPI dynamics on the back of moderate domestic demand and softening energy prices; 5-10yr bucket and CPI-linkers attractive; solid bid for local bonds since inclusion in WGBI fully intact; MXN remains strategically cheap; little FX intervention risk
• BRL (11.2%; +9.2% o/w): High nominal/real carry; CPI moderating but risk still tilted to the upside; steepening bias in light of Copom policy shift; we prefer combination of shorter-dated nominals and longer-dated CPI-linkers; softening stance re FX appreciation but some intervention risks remain
• IDR (10.2%; +8.1% o/w): Attractive curve shape and carry; CPI peaking; policy tightening to focus on FX - not Rates; curve to flatten with longer-end nominals preferred; small fiscal deficit; diversified commodity play
• HUF (9.8%; +4.2% o/w): Added exposure both in FX and Rates after mid-month sell-off as a tactical “risk-on“ switch at the expense of Turkish risk
• SGD (8.8%; -1.6% u/w): Prime candidate to fight CPI through FX; robust GDP & C/A surplus; CPI peaking
• Key FX o/w are BRL, HKD, IDR, MYR, HUF, UYU, MXN and KRW vs. u/w in TRY, CZK, RUB, PLN, ILS and ARS
• The fund´s weighted average credit rating (ex cash & cash equivalents) was further raised to an A-, or one notch below implied BM levels, as we added to IG issuers (HK, Chile, Brazil, Russia, Hungary) while cutting exposure mainly to Turkey. 97% of bonds is held in EM-domiciled issuers, made up predominantly of sovereigns."
Jacob Elbækgaard Jensen, Portfolio Manager, "Jyske Invest Emerging Local Market Bonds" (20.09.2011): "The portfolio is currently overweighted in current account surplus countries with strong debt dynamics (Thailand, Indonesia, Malaysia). We favour these countries on behalf of Russia, Poland and Hungary. Given the current uncertain situation in Europe and stagnating global growth we see these countries as the most attractive.
The portfolios is 100% local currency and we do not have corporate credit risk (except if the company is 100% government owned)."
David Dowsett, Portfolio Manager, "BlueBay Emerging Market Local Curr Bd USD Base" (21.09.2011): "Due the uncertain investment environment we have taken a more defensive stance across our emerging market bond funds in both the hard currency and corporate space. We will look to take advantage of more undervalued opportunities when a suitable entry point arises. We have also reduced our holdings of local currency debt as we believe local FX could remain volatile as many emerging market countries will look to see how the debt situation in both Europe and the US is handled by governments and policy markers alike."
Hans Christian Backman, Portfolio manager and Emerging Markets strategist, "ISI Emerging Market Local Currency Bonds" (14.09.2011): "ISI EM Local Currency Bonds:
Largest overweights (Largest top)
Argentina
Ghana
Philippines
Nigeria
Brazil
Mongolia
Iceland
Kazakhstan
Serbia
Mexico
Largest underweights (Largest top)
Malaysia
Hungary
Thailand
Indonesia
Poland
Russia
Turkey
South Africa
Peru
Colombia
No corporate bonds.
100% local currency bonds or cash."
Question 5
e-fundresearch: "Did your fund outperform or underperform vs. benchmark over the past 5 years and which part could be linked to securities selection (Performance Attribution)?"
Sébastien Unger, Senior Product Specialist for Fixed Income and Balanced Products, "Pictet-Emerging Local Currency Debt-P USD" (20.09.2011): "Yes the fund did outperform its reference becnhmark on a 5 years basis and is within the range that we target. This result was achieved by taking active currency and interest rate exposure on individual countries as well as the use of proxy developed trades to ensure an appropriate liquidity in the portfolio and has remained true to the investment process."
Ernesto Bettoni, Investment Spezialist Emerging Markets, "BNP Paribas L1 Bond World Emerging Local C C" (20.09.2011): "We outperform by 65bps as of August 2011 in our local debt strategy for the past 5 years. This has been very well distributed between FX and interest rates decisions. Both country and security selection have been positive. The fund has an extremely solid 5 years return against its peers."
Ralph M. Gasser, Senior Product Specialist Fixed Income, "Julius Baer BF Local Emerging-USD B" (22.09.2011): "The fund has materially outperformed market and average peer group returns over virtually all time series. Given that this is an asset class driven mainly by top-down themes and country selection, bond selection typically plays a subordinated role, at least in terms of aggregate returns."
Jacob Elbækgaard Jensen, Portfolio Manager, "Jyske Invest Emerging Local Market Bonds" (20.09.2011): "The fund underperformed the benchmark over the past 5 years. The majority of the underperformance are related to the post Lehman period with a massive outperformance of Asian Fixed Income and FX markets. Performance from selection of bonds is the least contribution to excess return. Duration and FX exposure on country level are the largest contributors."
David Dowsett, Portfolio Manager, "BlueBay Emerging Market Local Curr Bd USD Base" (21.09.2011): "Over the past five years (to 31 August 2011) the BlueBay Emerging Market Local Currency Bond Fund has outperformed its benchmark, the JP Morgan GBI-EM Broad Diversified USD unhedged. Outperformance is primarily a result of FX selection, with an underweight position in the South African rand and positions in the Korean won and Hungarian forint contributing positively to returns."
Hans Christian Backman, Portfolio manager and Emerging Markets strategist, "ISI Emerging Market Local Currency Bonds" (14.09.2011): "We outperformed in 2009 and 2010 but underperformance in 2008 weights heavier."
All performance data per 12.09.2011:
