Summit Funds Focus: EMD is nowhere near a “bubble” asset class, says Standish Mellon manager

Emerging market debt (EMD) is not experiencing a bubble, and given improving fundamentals for the asset class, it may instead be at the start of another run higher, according to Cathy Elmore, portfolio manager, emerging market debt at Standish Mellon Asset Management, one of BNY Mellon Asset Management’s 16 boutique subsidiaries.

The BNY Mellon Emerging Markets Debt fund was the winner of the InvestmentEurope 2012 Emerging Market Debt Fund of the Year.

Elmore agreed that the EMD asset class has grown rapidly over the last five years. “But I don’t agree that EM debt is a bubble,” she told fund selectors at IE’s annual investment Summit in Lausanne, Switzerland.

“It may look expensive relative to recent levels but it could get even more so. Emerging markets will account for more than 50% of global GDP in five years. This is a buying opportunity.”

She points to the “resilience” of the asset class since the financial crisis. “No-one is saying there is a de-coupling, but EMD tends to bounce back from lows quite quickly.”

That is not surprising, because the underlying economic fundamentals are strengthening. Emerging markets debt was “the last domino to fall” as the global financial crisis intensified precisely because of the improved creditworthiness of many developing countries, and the growth differential with developed economies.
Emerging countries have increased foreign reserves, lowered foreign debt ratios and pursued more credible monetary policies. In 2011 debit rating upgrades outpaced downgrades: the average rating of the Emerging Market Bond Index Global from S&P is a “solid” BBB-.

Up to 2007, EM local debt outperformed EM credit (sovereign and corporate) due partly to pressure on the US dollar and widening credit spreads. More recently, dollar-denominated bond funds experienced greater inflows than local currency bonds, as investors chose the “safety” of a dollar association. But as US Treasury yields move upwards, this may reverse.

“Given the improvement in the weighted average credit quality of the asset class to investment grade, at current levels spreads offer a more than adequate compensation for the potential credit losses,” a presentation note said. “The underlying US Treasury yields appear overvalued from a fundamental perspective.”

Steady positive local duration returns (suggesting that local bonds have outperformed currency forwards) reflect the positive term premium of local yield curves. Managers can use currency forwards to invest in countries where the currency rate is attractive but prospective duration returns are not. In several countries, inflation-linked bonds are also available.

The team’s investment philosophy is based on identifying long term structural opportunities, rather than relying on short term capital flows. Managers are willing to explore opportunities but also put strong emphasis on “avoiding costly mistakes”.
Elmore said the qualitative process is “supported but not over-ridden” by quantitative models. To minimise the chance of negative surprises, managers must employ a set of overlapping risk management techniques.

Answering a question from a delegate fund selector, Elmore said official debt ratings remain important. “We are not wedded to watching ratings, but doors do open or close with the attainment of investment grade ratings,” she explained, adding that the market is usually well ahead of the ratings announcements.

 

For full details on the InvestmentEurope Fund Manager of the Year Awards, including details about the methodology and categories, visit: http://events.investmenteurope.net/awards

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