Risk adjusted returns important to understanding EM debt opportunities

Emerging market bond funds are like any other, with top line return figures not always indicating the level of risk taken on by the investor.

Emerging market debt is increasingly popular, especially as its quality has improved relative to developed market debt of the eurozone and US.

Economies in Latin America and Asia have learned to live within their means, and are benefiting from much faster growth.

But how does the data look? We started by filtering out funds across different EM debt universes. From this, we created a list of top returning funds over three years to 23 September, with returns rebased in gross euro terms.

One of the top performers is the Reliance Monthly Income Plan, with a return of 54.36%.

According to FE data, its top holdings are predominantly Indian sovereign debt and Indian corporate debt.

The Malaysian KAF Bond fund returned 52.54%. Another Malaysian product, the AM Dynamic Bond fund, returned 51.3% investing in a mix of medium- to long-term sovereign and corporate debt, with credit rated at least A3/A-.

Rounding up the 50%-plus club are the Stanlib Aggressive Income (a South African unit trust that also puts a significant share of the portfolio in property and global fixed interest) and the Stratton Street Renminbi Bond fund, with a return of 50.37%.

Filtering the same group for overall TERs, the top performers include Allan Grey Bond fund, a South African unit trust, but that returned 43.32% against a TER of 0.38% from a portfolio of gilts, cash and money market instruments.

The Nedgroup Investments Bond fund, from South Africa, achieved a TER of 0.61% against a cumulative return of 43.57% over the period from a similar portfolio set-up.

The Momentum Bond is short derivatives and liquid assets, and long gilts and money markets, to provide a return of 42.01% against a TER of 0.9%.

But consider the Reliance Monthly Income Plan. Its performance came with a TER of 2%. The same is true of the Stanlib fund, which came with a TER of 1.42% and the Stratton fund, with a TER of 1.46%.

So far, then, the data suggests that Indian and Chinese fixed income assets may be capable of producing top headline return figures.

But once costs are factored in, the investor should, perhaps, be looking at products from South Africa or elsewhere.

Volatility

Looking at the figures for three-year cumulative, annualised volatility suggests that the Stanlib Aggressive Income fund was far more volatile than other members of the 50%-plus club.

Its volatility figure of 21.82% over the period was about 10% higher than any of the other similar funds.

But lower cost itself was also not a guarantee of sleepless nights. The Allan Gray Bond fund shows a volatility score of 19.7%.

The Nedgroup Investments Bond fund volatility was 20.38%, and the Momentum Bond fund saw volatility of 21.01%.

Emerging market debt focused on South Africa was, then, more volatile than debt elsewhere, while some Asian fixed interest assets may be less so, the data suggests.

Two of the more common measures of managers’ skills – Information Ratio and Sharpe – throw up yet another area to consider: Sharia-compliant fixed interest.

The CIMB Islamic Enhanced Sukuk fund is 61% invested in Sharia-compliant fixed interest securities, with some 15% in Sharia compliant equities, and the rest in cash.

The fund’s managers said at the end of August that they continued to see more opportunity in corporate bonds than Malaysian government securities.

The fund’s information ratio figure of 1.28% is matched by a Sharpe ratio of 0.95%.

Closer to home, the Legg Mason Western Asset Emerging Markets Bond fund ­with a 48.65% return over the period against volatility of 15.01%, has done well out of exposure to ­sovereign debt.

For half as much volatility (10.37%) and nearly the same return (48.48%) the OMGB Emerging Market Bond fund shows that investors could consider the likes of Iraqi sovereign debt.

And a 40% weighting to BBB does not seem to be harming the Aberdeen Global Emerging Markets Bond fund. A return of 46.15% over the period is achieved against risk of 14.19%.

Its portfolio illustrates why the label “emerging markets” should not be seen as a proxy for lower per capita income.  

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