AsianInvestor: How much do you manage in emerging-market debt assets?
We manage around $20 billion in EMD, making us one of the world’s largest managers in this asset class, which gives us a good view on what investors are doing. Besides managing hard-currency EMD, we have Asian, Latin American and global EM local-currency debt funds. About three-quarters of our assets are local-currency-related.
What sort of risk appetite are you seeing from investors in Asia and elsewhere for EMD?
Investors are increasingly interested in moving into the EMD space – both those based within and outside emerging markets. We have seen the asset class move from being very niche to become more mainstream.
We’ve also seen asset owners and intermediaries become more risk-averse following the 2008 financial crisis, so they are looking for more stable investments, such as fixed income.
And institutional investors with allocations to, say, global fixed income have been moving towards more specific allocations to EMD, in particular local-currency debt. That’s in line with Pictet’s long-term view.
What sort of exposure are we talking among institutions?
Among large asset owners, usually EMD allocation is still not that high – perhaps 3% to 5% of their total fixed income portfolios – but we have seen some with allocations as high as 10%.
Early investors into specific EMD allocations are increasing their exposures, while many are making their first investments. This is in line with our belief that the strong fundamentals of this asset class will deliver attractive return potential for investors over the long term.
Why are investors increasingly seeking EMD exposure?
We see capital moving into this asset class, as the return component is very attractive – bonds provide a very stable return and the local-currency side provides appreciation as well.
Pictet’s portfolio managers’ ability to manage rates and currencies separately is very important. For example, if we like Indonesian bonds but we don’t like the outlook for the rupiah, we will strip out the currency exposure in our active positions.
In the long run, beta from EMD will give positive returns by itself, but active management is important, given the volatility of emerging markets. Plus we want to beat the market.
What sort of returns has EMD provided in recent years?
If you look at the past 10 years across all asset classes globally, emerging equities have posted annualised returns of 18% and emerging local-currency debt returned 15%, but with far lower volatility. Hard-currency EMD has gained 13% on an annualised basis over the same time period.
In the past decade, there were only two negative years for local-currency EMD: in 2008 (–5%) and 2011 (–2%), which were relatively minimal losses, compared to drops of as much as 50% on equities.
As a result, EMD is very attractive on a risk-adjusted basis, and hence the interest from large institutions.
How about Pictet’s own funds’ recent performance?
In terms of near-term performance for EMD, last year Emerging Local Currency Debt returned -1.75% (based on JP Morgan GBI-EM Global Diversified), while Emerging Hard (USD) Currency Debt posted +7.35% (based on JPM EMBI Global Diversified).
So far this year, however, local-currency EMD is slightly ahead with a return of +9.75% as at the end of April versus a 6% return for Emerging Hard (USD) Currency Debt.
As for Pictet’s performance, over the full market cycle of the past five years, when our investment philosophy and process has been truly tested we have been able to deliver consistent performance while maintaining risk at a modest level, resulting in a strong information ratio.
How about capacity concerns? Are there enough EMD issues available to sate demand?
There are more concerns about capacity than is justified by the level of demand today. And the number of bond issues and liquidity of the market has improved quite a lot compared to five years ago. We look at capacity closely in EMD and other markets – but we don’t see a problem currently.
To what extent do you allocate to EM corporate credit?
Sovereign debt is much more liquid than corporate credit, but Pictet does invest in credit via off-benchmark allocations. It can invest up to 30% of its EMD portfolios off-benchmark (in, say, corporate issues or non-investment-grade sovereigns). And the Asian corporate credit market is developing fast.
Pictet has some dedicated resources looking at EM corporate credit, but is in the process of hiring more in anticipation of future market developments.
What are the issues around corporate credit?
Corporate bonds offer higher credit risk, so the question is whether their risk profile justifies adding credit to the portfolio, given that generally EM sovereigns can give good returns. But that doesn’t mean we should ignore the credit segment.
However, investors don’t usually talk yet about specific allocations to EM credit. We have some room to manoeuvre in terms of how we can increase allocations to credit without going outside clients’ risk guidelines. Some investors are being quite receptive to doing this.
Also, in terms of allocation between hard- and local-currency debt, we have experienced a broad range of investor choice between the two. However, in the last four years the bias has been for a higher portion in local versus hard currency: an approximate figure is 70:30 in favour of local-currency.
What we have witnessed, though, is that the two asset classes are indeed very different from a risk and return perspective, and this choice enables investors to optimise this. Last year, for instance, there was a stark contrast between local returns and hard-currency. Currently, we would recommend a slight bias for local markets perhaps in the range of 60:40.
In addition to EMD, does Pictet offer any less conventional fixed-income strategies, such as non-market-cap-weighted products?
Pictet does now offer a global fundamental bond strategy, which was launched last year. Given the eurozone crisis and other developed-country debt concerns, some clients feel that market cap-weighted indices are not the best way forward, as they overweight such developed markets.