CEE: Investing beyond the headlines
“People tend to follow headlines, in which case they will have to pay a premium when they unwind their positions on negative news in order to feel safe, but the substance of those headlines is often questionable,” says Aristoteles Damianidis, portfolio manager fixed income emerging markets at UBS in laying out his argument why fixed income investors should look to Central and Eastern Europe (CEE).
“We believe that it is worth giving some countries in Central and Eastern Europe a closer look. That requires being present on the ground and subjecting investment opportunities to a thorough bottom-up analysis. Not every headline corresponds to realities on the ground.”
“If investors have exposure to the region, it is mainly through equities, such as Russian stocks as it is by far the biggest stock market in the region, whereas the fixed income side offers broader diversification potential,” he argues.
Damianidis is part of a ten person strong team at UBS in Frankfurt, specialising nin European bonds. Supported by some 60 credit analysts, the team aims to pursue an active investment strategy which is relatively unconstrained from its reference indices, the JP Morgan Euro EMBIG Diversified Europe and the JP Morgan Euro EMBIG Diversified Europe /50% JP Morgan GBI-EM Global Europe.
“We aim to have a tracking error of 2-3% and so far we have managed to stay within this range,” he says. The fund’s performance target is to exceed its reference indices by 1%. In the second half of 2014, the fund returned -4.46%, according to Lipper Hindsight. However, over a five year period, it returned 37.45% and outperformed its benchmark, albeit with volatility levels of more than 8% over a five year period.
Nevertheless, Damianidis stresses that the fund has been gaining traction among both institutional and even retail investors in Germany. mWhile the past year has been challengingm for investors targeting CEE,
Damianidis identifies three structural growth drivers for the region. First, he sees the artificially low level of bond yields as a positive factor influencing the risk premium of bonds of CEE countries, with local rates curves being positively affected by the level of rate curves in the eurozone.
Secondly, Damianidis predicts that the geopolitical tensions between Russia and the Ukraine will ease. “For the past year, risk levels have continued to build up and we have sold all our exposure to the Ukraine. But in the Minks 2 agreement in January the two have managed to agree on further deescalating steps like the continuation of a gas deal, which is a significant sign of progress,”he says.
Thirdly, he argues that oil prices are now set to stabilise, which would have a positive impact on oil exporting countries in the region. Given the current levels of volatility, a tempting scenario would be to use hedging strategies in order to build up negative exposure. Yet the team has decided against this approach. It has used credit default swaps in the past, but “in general, we do not want to build up negative exposure to countries and we don’t aim to be an absolute return fund.”
Instead, Damianidis highlights the potential of sovereign bonds in relatively smaller and under researched Balkan countries including Albania, Serbia and Montenegro. “In these countries, the prospect of EU membership has a disciplining effect,” Damianidis argues. In contrast, the fund is not invested in any Greek bonds.
In terms of geographical weighting, 21.9% of the fund’s portfolio is currently invested in Russian bonds, 17.5% in Turkey, 10% in Poland, 9.9% in Hungary and 6.5% in Montenegro. “We do seek exposure to local currencies in countries where we see growth potential but around half of our investments are denominated in euro.” Other top currencies within the fund are the Polish zloty (17.2%), the Turkish lira (11.6%), the Russian rouble (8.4%) and the Hungarian forint (5.6%).
Looking ahead, Damianidis stresses that there are good reasons to look eastwards: “With current yield levels in developed European countries at record lows, I think a lot of investors
will look at opportunities such as Hungarian or Polish fixed income in a different light.”