Sovereign Rules

Will Foggon discovers two emerging market sovereign debt funds that have performed excellently over a five-year period and demonstrates with low volatility .

The purpose of this feature is simple: we have tried to identify just two offshore emerging market funds that have consistently outperformed their peers, have brought in the bread for those who are invested, and have demonstrated acceptable volatility over a three year period. Which makes a feature on emerging market debt funds seem like something of anathema, right? Wrong.

It is true that international investors have viewed emerging markets with a high degree of scepticism since the 1997 crash which saw speculators desert the asset class for good. And those who have remained invested have had to endure poor performance. Running your finger down a list of global emerging market equity fund will leave you in little doubt that they are pretty useless performers.

The average five-year returns for global emerging market equity funds is US$71.54 from US$100 invested – more than a 28 per cent loss (and that’s not counting what you could have made in interest from, say, cash in the bank).

This woeful performance – emerging markets are worse than other sectors - can be explained in part by the global downturn that damaged dependent emerging economies. Simply, emerging market equity funds tend to outperform when the global economy re-ignites and freed-up capital can pour in.

Emerging market debt funds, which have only really existed since the early 1990s when Brady bonds were introduced, have exploded onto the investment scene: ten years ago there were just six. Now there are more than 120.

And yet among retail investors the class has largely been shunned, partly due to its relative youth. But, say the specialists, partly due to risk averse investors shying away from an area they see as high-risk.

The two funds we cover in this article are both emerging market government debt funds that are well diversified and have experienced investors at the helm.

The first fund we have identified as a solid long-termer is the Ashmore Emerging Markets Liquid Investment Portfolio (EMLIP) which, ever since its launch in October 1992, has achieved annualised returns for investors of 18.84 per cent.
According to Jerome Booth, head of research at Ashmore, the fund does well because it has a team of experienced advisers, its investment strategy, and the wide range of instruments it invests in.

He says: “There’s a team of ten investment advisers who have an average of ten years’ experience. We’re also a market maker, so we have contacts with a lot of [bond] issuers. All of that makes a huge difference to the concentration on detail. Quite simply we can invest in instruments that other managers don’t know exist.”

This, in turn, means the fund invests in a wide range of instruments than most fund managers. There are more than 100 debt instruments in the fund, which help keep volatility down to such a low level (3.8 per cent). The fund invests in 35 countries, which is far more than most, if not all, emerging market debt funds and has minimal exposure to Argentina – the one black spot on the emerging market horizon.
Ashmore employs its own in-house strategy that aims to keep volatility low without damaging growth. It consists of categorising emerging market bonds into three types: yield, total return and special situation.

Yield means bonds with a better average credit rating than most emerging market funds. These are the most tradable funds and are used to reduce risk when markets are uncertain or poor.