By Katie Llanos-Small
The aftermath of the global financial crisis has been unkind to
some. But for the emerging markets, successive years of
economic gloom in the developed world have proved anything but
Ultra-low interest rates in the West have given rise to a
surge in capital flows to high-growth emerging regions. And
investors betting on emerging market debt have had an
impressive run: simply tracking the JPMorgan EMBI Global Index
would have returned over 10% on an annualized basis over the
three years to the end of March.
The top managers have done much better. The funds in
LatinFinance's 2013 debt investor scorecard have all beaten
GMO's Emerging Country Debt Fund tops the ranking, with
returns of close to 17% over the past three years. The $2.3
billion fund allocates close to 40% of its assets to Latin
When it comes to replicating such returns in the years
ahead, top managers say local currency paper and corporate debt
offer the best opportunities.
"The greatest value in the next 12 months will be
combination of corporates and local currency bonds," says
Blaise Antin, head of sovereign research at TCW.
The firm's $7.3 billion Emerging Markets Income Fund
returned 14% last year, and 15% on average over the past five
"In local currency, we've been biased in favor of Mexico,"
he says. "The peso has been the best performing currency this
The local yield curve responded favorably to rate cut in
March - the first such move since 2009 - and any further easing
would likely contribute to a further rally in local bonds,
TCW is not alone in liking Mexican peso-denominated bonds.
The currency has steadily strengthened since June 2012 when it
traded at 14.31 to the dollar.
Enthusiasm about ambitious reforms being driven through by
the new Enrique Peña Nieto-led administration pushed the
currency up to 12.32 to the dollar in early April.
Sam Finkelstein, portfolio manager at Goldman Sachs Asset
Management, also lists peso paper as a favorite.
"The potential is strong for FDI into oil and gas if the
government is able to push through reform," he tells
LatinFinance. "The story overall is a positive one."
Goldman's $2.9 billion Growth and Emerging Markets Debt Fund
returned 12.6% in the year to the end of March, and has
averaged returns of 11.8% over the past three years. Local
currency allocations made up 4.5% of the portfolio in February,
with three-quarters of that in sovereign paper.
Debt denominated in Brazilian reais also offers some value -
particularly when held up against Brazilian in dollars,
"Generally I'd be critical of the level of investment, the
role of government, and would like to see more reforms," he
"A lot of the positives, terms of trade and credit growth,
are behind the country. The only investment we like is local
bonds with the FX hedged." Brazil local bonds offer high
nominal yields at roughly 9.5%, he notes.
Local currency bonds are not attractive everywhere, though.
Colombia last year cut the tax on profits earned by foreign
investors in the local market from 33% to 14%. While that may
lure some more investors in, overall the market is not exciting
international portfolio managers, says Antin.
The Colombian peso has dropped 3% year to date and there are
concerns it could depreciate further. "With the central bank
cutting rates and the government talking down the currency,
it's hard to get bullish," he says.
The yields on offer on Colombian paper are unattractive for
many international accounts.
"In local markets, we look for a combination of high carry
and the prospect of currency appreciation. Appreciation isn't
really something we're going to find in the Colombian peso over
the next six to 12 months. As for carry in the local market, we
currently see better opportunities among some Colombian
corporates compared to government bonds."
Despite appreciation pressures, the Peruvian sol is also
flagging this year, following intervention by policymakers.
Mexican local currency bonds helped Aberdeen's Emerging Markets
Bond Fund in January. But overall, portfolio manager Edwin
Gutierrez says emerging market currencies have not performed as
well as some expected this year.
"We came into this year thinking it would be a decent one
for emerging markets currencies," he says.
"EM equity inflows are supportive, but strong EM currencies
haven't materialized. There's a home bias, and buying of US
assets has led to dollar strength versus euros, yen and
emerging market currencies. It has been difficult for local
currencies to rally with a strong bid for the dollar."
Aggressive monetary expansion in developed markets has
ramped up another long-lingering concern for debt portfolio
managers in LatAm: inflation. But there are home-grown factors
also at play.
At 0.9% in 2012, Brazilian growth is a concern for the
entire region, says Antin. While government measures are
expected to prompt a rebound - analysts at Itaú reckon
the economy will expand 3% this year and 3.5% in 2014 -
investors are also vigilant for signs of inflation.
Antin says the worry is that the central bank will "push the
boundaries a little too far" and focus excessively on growth at
the expense of price increases.
"If the policy mix results in rising inflation pressures -
either in Brazil or other countries - inflation-linked bonds
can provide an important safety valve for fixed income
investors," he says.
The central bank may offer a couple of "symbolic" rate rises
this year, says Gutierrez, but this is unlikely to
counterbalance inflation expectations. Investors are turning to
products that will hedge against that risk. "There's good money
to be made with inflation-linked bonds, although it's been a
crowded position," he says.
A bigger worry looms over Latin debt, however: the
possibility that interest rates in the US rise more sharply
than expected as the economic recovery in the north gathers
pace. That prospect is already taking the shine off long-dated
Latin debt at tight yields.
Chile, Colombia and Mexico have all issued tightly priced 10
and 30-year bonds in recent months.
While Mexico's tap of a 2044 bond in January, for example,
was twice subscribed despite the 4.194% yield on offer, the
returns on some long-dated bonds in the primary and secondary
markets were simply too tight for some accounts to play.
Says Gutierrez: "We didn't think a 4% yield was attractive
for a 30-year bond from the lower-beta names like Panama,
Brazil, Colombia, Peru, because we're constructive on the US
Debt managers wanting to hedge against a possible US rates
rise have found another route for decent returns in high beta
sovereign paper over the past 12 months.
Several governments have taken advantage of the global chase
for yield to stage returns to the bond market. Fund managers
have not seen value in all of them.
Bolivia's reentry to the debt market in October with a
10-year bond yielding 4.875% was too much for some - although
there was heavy subscription for the deal.
In contrast, Honduras' 2024 bond sold in March offered 7.5%
"Honduras has some challenges, a large current account
deficit, high fiscal expenditure, and elections next year,"
says Finkelstein. "We see more value in Honduras then some of
the newer smaller issuing countries like Bolivia."
Venezuela, however, is one sovereign credit that continues
to pay handsomely. "This was a very good trade for investors
the last few years," says Antin.
"During 2012 Venezuela was an enormous outperformer,
returning more than 45%."
Investors who shunned the credit last year because of
headline political risk "missed out on one of the best
performing credits in the EM sovereign index," he says.
TCW had 2.69% of its Emerging Markets Income fund allocated
to state oil company PDVSA and 2.64% to the Republic of
Venezuela at the end of 2012, its fourth and sixth-largest
As for Argentina, says Finkelstein: "one would probably be
better served with a legal degree rather than an economics
degree to understand its challenges." LF