A "GEM" OF AN INVESTMENT?
(Fundsupermart.com) - UOB Asset Management's latest product is a marriage of two concepts - bonds and global Emerging Markets. The United Global Emerging Market Portfolios or GEMs for short, invests primarily in government bonds issued by emerging economies in Latin America, Europe, Africa and Asia. The fund is broadly based on the Emerging Markets Liquid Portfolio or EMLIP and is managed by Ashmore Investment Management, an award winning boutique firm that specialises in Emerging Markets. Since its inception in November 1992, EMLIP has had an average annual return of 20.19%. It was also ranked the "number one Emerging Markets fund" over a 5-year period by Lipper last year (see our story in New Funds).
Although the concept of an Emerging Market debt fund is rather new here, Ashmore's Managing Director and lead fund manager for GEMs, thinks it's an idea that will catch on. Mark Coombs says that Emerging Market debt is increasingly seen as a distinct asset class, and thus offers investors diversification. It also has greater growth potential than standard global bond funds, and is only slightly more volatile than the S&P 500 Index, adds Coombs. He spoke to Fundsupermart about the United GEMs Portfolios.
Bharathi: What's the outlook for Emerging Market bonds?
Mark Coombs: Emerging economies represent 84% of the world's population and they have a general improving credit trend as they develop economic growth. Emerging Market bonds are principally issued by countries. As a country improves its GDP capability and its fiscal balance, it's able to generate more dollars to service that debt. So there is a general credit trend upwards for the Emerging Markets, which is picked up first in the debt market.
There is also an increasing lack of choice among sovereign bonds. The amount of debt issued by governments within the G20 has shrunk with the creation of the EURO and suddenly investors in global bonds are forced to look beyond the Europe. Another element is that many governments are repaying debt in a low interest rate environment. The UK, US, Australia and a lot of the G7 and G20 countries are repaying debt at the government level.
As a result, major indices like Lehman Universal Index are now increasing their exposure to Emerging Market sovereign debt. Over the next 3-5 years, some estimate that 25 to 40 billion dollars will be re-allocated to emerging market bonds. It won't happen all at once, but it'll happen as people review there compositions and make sure they keep up with the index.
B: There's a perception that Emerging Markets are very volatile. How applicable is that to the Emerging Market debt?
MC: The best way to look at these things is to look at the historical risk numbers over a period of time. (see table in our New Funds story). In the last 8 to 10 years that we've been in the business, Emerging Market debt using standard deviation as a measure of volatility - i.e how much does the fund go up and down due to movements in the underlying asset prices - shows an annualized volatility of 17%. This compares to a volatility of 25% for Emerging Market equities. So if you are going to invest in either Emerging Market debt or equity, then equity is more volatile. Volatility for the S&P 500 Index over the same period is around 15-16%. So Emerging Market debt is just slightly more volatile than the S&P 500. Of course its obviously more risky than buying the premium single-A or triple-A rated government bonds.
"The way we manage the fund is that we restrict how much we have in any one country at any time so that gives us some protection. We cap ourselves by country and not by sector."
B: How do you balance political, economic, currency and default risk?
MC: We have an investment process which we call Ashmore Portfolio Framework. We have a 5-stage process and use this to manage liquidity and reduce risk. First comes the evaluation of the global environment for liquidity. We look at interest rate pressure especially with regard to the US dollar and the Japanese yen. Second, we look at the country's macro-economic picture, including their ability to pay their debt. We look at whether they are accumulating surplus, whether they are collecting their taxes and what is their debt-to-GDP ratio. The third issue then is how US politics and domestic developments affects the country's ability to pay.
The fourth level is asset specific. We look at the actual underlying credit, and we analyze the default risk. For the fifth stage we take a technical view of the market. We may delay an investment decision because we don't like what is going on in the market. We keep very close to what the market is doing and what volume of buy and sell orders is going through.
Our style is specialist and active. Our investment managers and researchers are visiting these countries very often. In fact I don't think we've ever had everybody in the office. We restrict how much we have in any one country at any time so that gives us some protection. We cap ourselves by country and not by sector. We don't have more than 25% in any country. The Index that we follow is based in 26 countries. We are even more diversified than that. We have 103 debt instruments in 33 countries.
"Our focus tends to be on unrated bonds to those just touching investment grade where we invest. Once it gets above a triple B rating, it's normally moving out of our horizon. Once it gets to single A rating and above, we are not investing there."
B: Which countries do you favour and why?
MC: Before 1998 we hated Asia because it wasn't cheap enough. But now we like Asia. There are parts of Asia that we like a lot. We liked Korea a lot in 1999, we went off it a bit in 2000, but we like it a lot now. The last 6 months we have had a good Korean weighting. We like China corporate bonds, but not China government bonds. We don't like China goverment bonds because it does not pay for its risk, which means the yield is too little. We like China corporate bonds at the very low grade end which is the restructured and distressed end. Case by case, we have found some good deals. In Asia we now tend to find a lot of interesting corporate stories, companies that have blown up but are now recovering. China is one place, there have been a few interesting developments in Philippines, Indonesia.
We love Korea. It's our second largest holding. And the reason we love Korea is that we think that the market is completely mispricing the risk of their government owned bank debt. These are the banks that have been pieced together after having let go the banks they wanted to let go. I don't think the market understands the risk, and you are being paid a huge spread for that. We think Korea's credit trend is upwards from here. They are now going through some corporate restructuring and there is going to be some ugliness around it, but they are working their way through. Korea has been a real flight to quality in the last 3 months.
B: What is the investment rating for the bonds that you buy?
MC: Our focus tends to be on unrated bonds to those just touching investment grade where we invest. Once it gets above a triple B rating, it's normally moving out of our horizon. Once it gets to single A rating and above, we are not investing there. After that there isn't enough change or events. We like event risk, and managing it for profit. We like things going wrong and then going right. The problem when you get to triple-A, single-A and double-A is that the degree to which things go wrong then right is much slower. There is less event risk and less sudden moves.
Mark Coombs is Managing Director of Ashmore Investment Management. He holds an MA(Hons) in Law from Cambridge University and joined Grindlays Bank in 1983. Following its acquisition by ANZ, he was appointed Head of Emerging Markets Group for ANZ Merchant Bank Limited in 1983 and Head of Markets for ANZ Group in 1997. He is Chairman of Ashmore's Investment Committee and is responsible for setting overall investment strategy of the funds managed.