Macro maestros: how top EMD managers are positioned

The last few years have seen some strong returns from funds in the Global Emerging Market Bonds sector, and a number of managers have high Citywire Manager Ratios.

GAM’s Paul McNamara, who manages the Julius Baer BF Local Emerging fund, is the top ranked manager in the sector over both three and five years, with a Manager Ratio of 1.38 and 0.68 respectively. He is also Citywire AAA rated across a number of countries.

In the past he has focused on crisis markets, avoiding the initial tumult but then getting back in when things are stabilising. He believes investors are often slow to return to recovering markets, and that a key way of adding value is to be among the first back in.

However, while this strategy has generated significant returns for him in the past he feels there are currently few opportunities in this area. ‘Those crisis markets are outside the EM universe now, such as Greece,’ says McNamara. ‘The only candidate we see now is Egypt, but it’s still a bit early.’

In the current environment McNamara says he has become very top-down in his approach. ‘It’s about having a good handle on global developments such as QE3 and the Chinese economy, and how these will affect emerging markets. We’ve seen a string of crises but we’re now in the recovery stage.

That’s the big story of the last three years - recognising it’s a top-down global macro-driven market and allocating the portfolio based on that.’ As long as interest rates in the developed world remain super low this will continue to be the case, he says.

McNamara attributes some of his success to following this approach aggressively. ‘In 2009 we were reasonably early because of our focus on the recovery trade. There was almost a one-to-one correlation between performance and how aggressive the manager was.

In the last couple of years I’ve been reasonably bullish and not especially focused on containing drawdowns. I’m at the active end of the scale; the role of an active manager is not to hug the benchmark.’

Top 10 managers in EM bonds (3 years)

Citywire manager ratio: the manager ratio reflects how much 'added value' in terms of outperformance against the benchmark the fund manager delivers for each unit of risk assumed, where risk is defined as not mirroring the index's return. It ties together the fund manager's personal career history with in Information Ratio of the underlying funds.

Future opportunities

He believes 2013 is going to look quite similar to 2012, but that everything will be more expensive. ‘Bond markets are less attractive. Interest rates are likely to remain low for a long time, but we have to keep an eye on one-off events. Our base case is to do the same sort of things, just less of them. We should see respectable positive returns, maybe high single digits.’

McNamara says there are currently few places that offer great potential for an emerging market bond investor. ‘Russia looks interesting as it opens the market to foreigners. Romania too, but we’re treading carefully. Egypt and Chile look interesting. We’ve reallocated out of our ultra-long exposure – we don’t want more than 10 years to maturity.

The big opportunity is risk management. I don’t think the emerging markets sector is a place where diversification works particularly well and I don’t believe it is particularly effective. We’ve cut back on Hungary a bit and gradually unwound some of the duration. We also own more inflation-linked bonds.’

He describes his positioning right now as relatively conservative. ‘Performance in 2012 was significantly more than we expected. We thought the growth picture in the US would be happier than it was. But the Europe situation was treated as fixed far more quickly than we expected.’

Top 10 managers in EM bonds (5 years)

Citywire manager ratio: the manager ratio reflects how much 'added value' in terms of outperformance against the benchmark the fund manager delivers for each unit of risk assumed, where risk is defined as not mirroring the index's return. It ties together the fund manager's personal career history with in Information Ratio of the underlying funds.

Top-down tactics

Thomas Brund, manager of the Sydinvest Emerging Market Bonds fund, is ranked second over both three and five years with a Manager Ratio of 1.29 and 0.56 respectively. ‘If you look at our funds, a lot of the performance in the last few years comes down to process and being able to replicate it year after year,’ he says. ‘The overall theme for our process is finding value in the countries we invest in.’

One of the major pillars of this strategy is a top-down approach. ‘We look at global risk aversion, global themes, geopolitical issues, what the Fed is doing, what’s happening in the eurozone,’ says Brund.

‘That sets the framework for overall risk. Where we can really make a difference is in our country selection and asset selection. We have created a country score model, COSMO, to rank countries on the basis of normal parameters such as growth, GDP and debt numbers.

'This provides a more or less objective view on how things are at the moment. It gives you the ability to take a second look at things and avoids the temptation to fall in love with certain countries.’

Brund only considers sovereign bonds, or corporate bonds where the entity is 100% government owned or run, so the fund has mainly sovereign risk. ‘The final phase is asset selection. The next thing is finding an actual asset you can invest in, whether they are plain vanilla or not. You can build models around them; that’s helped us generate returns. We look at attributions. That’s a crucial driver of gains.’ Brund says that since the firm became part of Sydbank around five years ago, the process has become more automated.

Emerging markets did not do that well in 2011, says Brund. ‘Returns were primarily generated by US Treasury rates going down. Last year was more of a spreads year. Spreads are now at levels where you start to question where they go from here.'

'Things look very compressed from a historical perspective. Government bonds are more or less close to zero, but from a relative perspective emerging market bonds are still quite attractive.’

Brund uses the COSMO model to reduce exposure to countries with limited potential relative to risk. ‘At the moment we’re in the process of removing some countries from the portfolio and taking a position in cash. These include Poland and Brazil, where we don’t see much potential for spread compression. This year will depend more on tactical trading. There are still some high beta countries but you have to be careful. It’s down to how you play countries such as Venezuela, Argentina and Ukraine.’

In the first few weeks of this year, says Brund, there appears to be a large amount of money that is waiting to be invested in anything with yield. ‘Emerging market countries are well positioned to absorb this money. We will see additional funds coming into the asset class. But one of the issues we have to face is that the economic situation in these countries is looking so good they don’t need to issue debt.’

Despite some headwinds, though, Brund believes there are still plenty of opportunities. ‘In the last year 10 or 12 new countries have come into the universe.

'That gives us fresh opportunities as well. We’re not restricted just to investing in benchmark countries. We like to be first movers in regions that may become benchmark countries further down the line. As much as we can we try to implement the COSMO model using a wide spectrum of countries from, for example, Africa, Asia, South America.

Emerging markets is still a really attractive asset class. There’s a lot of focus on dollar bonds but we’ve seen people interested in local currency bonds. People shouldn’t be afraid of them.’

Simon Lue-Fong, manager of the Pictet Global Emerging Debt fund, has overseen a total return of 63.75% over the last five years. He puts this performance down to top-down analysis. ‘I had a good year in 2009. I read the global macro picture right. I didn’t really believe in emerging markets decoupling. I was underweight currencies, and also reduced or got rid of illiquid positions. Then we put proxy instruments in the portfolio such as treasuries.

‘At some point emerging markets stopped trading in 2008 so I had to have quite good portfolio management skills,’ says Lue-Fong. ‘Assets shrank from $3 billion to $1 billion but I outperformed. It was a very interesting period. It definitely helped that our performance was good in 2008 versus the competition. We also got a three-year track record, then the asset class began to become very mainstream. It was like the opposite of a perfect storm.’

In 2009, the main thing Lue-Fong got right was predicting that local rates were going to fall. ‘This was more of a bottom-up call. We thought countries were going to cut rates. Our attribution has very little top-down; it’s very country specific.’

Overly defensive

In 2010, however, Lue-Fong says his luck ran out to some extent. ‘The portfolio’s beta was very high and I was very defensive. I was worried about three things: the China slowdown, European pressures and a US slowdown. They all came to pass. I expected to see some deleveraging on the back of it but we were too defensive. It was a frustrating period. I read the big picture right but the flow story trumped everything else. The lesson was: don’t underestimate the flow in terms of prices. But it wasn’t disastrous.’

Lue-Fong believes that emerging market debt is moving from being a niche to a much more mainstream asset class. ‘There’s now a big percentage with institutional investors. They will own the price action. Eventually, and this is the real flow story, allocations to emerging market bonds will become structural not tactical.’

Polina Kurdyavko manages the BlueBay Emerging Market Corporate Bond fund, and has returned 53.43% over five years. She notes that emerging market corporate bonds are still quite a new asset class, and despite high growth it often has a lack of dedicated resources.

Bottom-up bias

BlueBay feels it has taken advantage of this. When Kurdyavko joined the firm in July 2005 she was given a mandate to develop emerging market corporate bonds as a standalone asset class.

‘We have a real focus on bottom-up research. Ultimately if you look at emerging market corporate, there are over 700 issuers in 60 different countries. You can’t just employ top-down macro dynamics. You need to have a strong and well resourced research team, and we’ve invested a lot in dedicated emerging market corporate analysts.

'To my knowledge that was our key distinction from our peer group.’ The fund is focused on absolute style returns, which Kurdyavko says is helped by the fact she also manages an emerging market corporate bond hedge fund.

This article appeared in Citywire Global's Emerging Market supplement which was published in February 2013.