Baring Asset Management (Barings), the international investment management firm, believes that the ongoing structural change in global asset allocation following the financial crisis will favour emerging market local bonds. In particular, it predicts both emerging market pension funds and OECD-based pension funds will significantly increase their exposure to emerging market local debt.
Thanasis Petronikolos, Head of Emerging Market Debt and manager of the Baring Emerging Markets Debt Local Currency Fund, comments: "Emerging market local debt has produced attractive risk-adjusted returns so far this year and has proved resilient, despite a risk-averse environment due to the concerns surrounding the European sovereign debt crisis and the sustainability of global growth. Capital inflows to emerging markets are strong and rising, and improving fiscal and debt profiles continue to underline the credit quality of most emerging market economies."
"Furthermore, the fundamentals in many emerging market economies are favourable due to the region's strong economic growth potential as well as the relative strength of the banking systems and sovereign balance sheets. A lack of yield in alternative areas of fixed income means that investor demand for emerging markets assets remains strong."
Barings believes that, relative to their developed market peers, many emerging market currencies remain undervalued. It expects currency appreciation to be a main source of outperformance in the future, along with the income and capital gains potential that come from investing in emerging market debt.
Thanasis continues: "In terms of current asset allocation of the Baring Emerging Markets Debt Local Currency Fund, we continue to see value in Hungary, Mexico and Brazil government debt ahead of Russia and Turkey. In the case of Hungary, the higher spreads on offer over German bunds have proved attractive. We also believe that the Mexican peso has further room for appreciation against the US dollar in the coming months and our country exposure is running at 14.5% as a consequence. We remain underweight Russia and our small position here reflects our view that the market's full potential has yet to be realised.
Thanasis concludes: "With modest correlations against most developed fixed income and equity markets and a track record of delivering superior risk-adjusted returns, emerging market debt can improve the return to risk profile for investors when held as part of a global diversified investment portfolio."
Barings has a strong history and presence in emerging markets. It was one of the first investors in Greater China and Eastern Europe and was also early in both US dollar and local emerging market currency debt. With US$163 million* assets under management, the Baring Emerging Market Local Debt fund follows a top-down scenario approach. The fund targets strategic core positions with a medium/long term investment horizon. It employs tactical positions to exploit short term opportunities.
The fund, which has a four star Morningstar rating, uses the JPM GBI-EM Global Diversified benchmark. On a country basis, the top holdings include Mexico (14.4%); Brazil (13.5%); Poland (12.3%); Hungary (11.5%); and South Africa (10.0%)*.
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