Emerging market equities have failed to live up to high expectations in 2019, with the average fund from the Investment Association (IA) Global Emerging Markets sector lagging its counterparts in the UK, Europe, Japan, the US and Asia for the year as of late September. From trade war noises to problems in individual countries, the region has faced plenty of challenges.
Attractive yield
Flexible approach
Strong performance
Large investment universe
May yield less than some peers
However, that’s not to say there are no bright spots. If a focus on emerging market equity is not working out for most investors, those buying bonds in the region have fared much better.
Although generally less volatile than equities, emerging market debt can still carry hefty levels of risk. But emerging market bonds offer substantial yields to compensate for that risk, and stand out at a time when income has been hard to come by.
These bonds have also done well in terms of total returns. The average IA Global Emerging Markets Bond fund had returned 11.25 per cent for the year in sterling terms as of 25 September. This puts it ahead of the average returns for the IA Sterling Corporate Bond, High Yield and Strategic Bond sectors, and just marginally behind the average gilts fund.
As such, investors with a focus on yield should consider some allocation to this area. But the risks and complexities of emerging market bonds mean that a flexible approach with some level of diversification is best.
One name that stands out in this respect is M&G Emerging Markets Bond (GB0031286205). The fund had an attractive underlying yield of 5.75 per cent at the end of July, and has outperformed its sector average over one, three, five and 10 years to the end of August 2019. Importantly, it also takes a flexible approach that should help investors navigate an unpredictable asset class.
One important element of the diversification in the fund is how it approaches currencies. Emerging market debt can either be issued in 'soft' format, in the local currency, or in a hard currency such as the US dollar.
Local exposure can sometimes offer good returns, but can make a fund vulnerable to big currency moves. However, the M&G fund spreads its risk in this respect. It had around 30 per cent of its assets in local currency debt at the end of July, with its other investments in hard currency.
The fund also spreads its exposure across different forms of debt, with nearly 70 per cent of assets in government bonds and just over 30 per cent in corporate debt. The fund had positions with 114 issuing companies at the end of July.
As ratings agency RSMR notes, the fund’s flexible approach is designed to maximise long-term total returns, with the managers blending a top-down investment approach with fundamental analysis of individual bonds. The team seeks to produce a combination of income and capital growth, and does not attempt to invest in line with a benchmark index. This means it has a large pool to fish in and no requirement to back popular names the managers may lack conviction on.
The fund has been among the top performers in its peer group in recent years. Because of this, and possibly a more conservative approach, it might not pay as high a yield as some names in its cohort. But the volatility of this asset class means that investors should focus on consistent results from tried-and-tested approaches, rather than reaching too high for yield.
At a time when yield is increasingly scarce, emerging market debt is a good way to generate income, with the right approach. The sensible, flexible management of this fund makes it a good option. Buy. DB
