Fund Update: First State Emerging Markets Bond Fund Class A Hedged (Accumulation) EUR
Market review
October was a strong month for most risky markets, with global equities (S&P 500: +4.5%), Emerging Market (EM) equities (MSCI EM: +4.8%) and high yield bonds (US HY: +2.5%) all performing strongly. Commodities suffered broad-based losses as strong harvests put pressure on soft commodity prices (e.g. Wheat: -1.6%, Corn -3%), while the boom in shale gas continues to depress oil prices in the US (West Texas Intermediate, WTI: -5.8%). The European oil benchmark (Brent) had a positive return in October: +1.3%.
Hard Currency EM debt had a strong month as underlying US Treasuries were supportive, with 10 year benchmark yields falling by 6 basis points (bps). The Fed’s decision to keep asset purchases constant at USD 85bn in September continued to provide a tailwind into October, with the EM risk premium falling by 26 bps. The total return for EM hard currency sovereign debt amounted to 2.77% in October (in USD).
Argentina was the best performing credit in October (+10.1%). Recent decisions in the pending court case between the sovereign and a group of hedge funds in New York led investors to believe that a final adverse ruling is somewhat less likely and that the timing could be much later than previously anticipated. Furthermore, the strong harvest will stem the reserve depletion seen in previous quarters, and hopes were raised that Christina Kirchner will leave the political scene after her current term expires. Other strong performers were index lightweights Bolivia (+7.7%) and Honduras (+6.8%). In a month where no country showed a negative return, the underperformers were Jamaica (+0.75%), Lithuania (+0.76%) and Trinidad & Tobago (+1.04%).
Fund highlights
The fund increased its position in credits that have lagged the recent rally, for example by investing in Costa Rica and in newly issued bonds by the Dominican Republic. The former has upside potential if elections in early 2014 deliver a reform-minded government, while the latter is already consolidating its state finances.
In October we took profit on some long dated Indonesian bonds, which rallied strongly as global liquidity conditions were kept loose. In Venezuela we established an underweight position, as we believe that the current political leadership is increasingly factious. Worryingly the radicals seem to be gaining the upper hand and seem to be driving the economic agenda. The Venezuelan economic model looks stretched, as evidenced by the discrepancy of the parallel FX rate paid on the Colombian border, which is around seven times as high as the ‘official’ exchange rate, as locals are getting more desperate for US dollars.
October continued to be a busy month in the primary market as issuers took advantage of strong demand for EM bonds and the recent drop in yields. We participated in a number of well-priced new deals including a sovereign bond issued by Brazil, an Islamic Sukuk transaction by the Republic of Turkey and a Turkish bank.
Outlook and strategy
The major Central Banks (FED, ECB and BoJ) continue to drive markets, with announcements around the possible tapering of asset purchases in the US, the ECB’s assessment of the Eurozone and performance of Japanese asset prices moving markets violently. As a result, we expect volatile trading conditions to persist, but we also see attractive investment opportunities amid a very slow normalisation of the global interest rate environment.
We expect active primary markets for a few more weeks, as issuers complete their financing for this year or pre-fund some of their needs for 2014 ahead of the holiday season.
Emerging Markets continue to benefit from higher growth, favourable demographics and lower indebtedness compared with advanced economies. The IMF in its most recent forecast for 2014, reduced its real GDP growth outlook for Emerging Markets to 5.1%, which is still significantly higher than the 2.0% we expect advanced economies to grow.
