Emerging market bonds have performed very well this year, buoyed by unprecedented cash inflows as increasing numbers of investors have found this high-yielding asset class a relatively safe haven from the volatile equity markets of the developed countries. Indeed, according to the Financial Research Corp., emerging market debt funds received $712.2-million in new money through the end of April, after taking in $534.9-million in all of 2002. By comparison, the sector suffered an outflow of $553.1-million in the prior calendar year.
Despite renewed investor interest, emerging market bond funds remain overlooked and small — the entire asset class comprises only about $5.5-billion in assets.
Kristen Ceva, portfolio manager of the $95.3-million Payden Emerging Markets Bond Fund/R (PYEMX), emphasizes regional diversification in her portfolio and typically stays away from distressed-credit countries. In fact, as many emerging markets have recently had their sovereign debt upgraded to investment grade, Ceva has an increasing number of relatively high-quality issues to choose from.
For the three-year period through April, the fund gained 13.4%, on an annualized basis, versus an 8.8% gain for the average global bond fund. The fund’s annual expense ratio was increased from 0.80% to 0.90%, but remains below the peer group’s average of 1.38%.
Ceva has managed the fund since inception in December 1998.
The Full Interview:
S&P: What has driven this recent inflow of new cash into emerging market bonds?
CEVA: At both the retail and institutional levels, investors are reducing their equity holdings and increasing their exposure to fixed-income securities. Moreover, with low interest rates, high-yield bonds and emerging market debt have become more attractive. As the equity markets in the developed countries remain quite volatile, an increasing number of investors are looking for safer havens than stocks.
S&P: What kind of bonds do you favor?
CEVA: We invest in both sovereign and corporate bonds of emerging market countries which are showing improving macroeconomic and political trends. We like to emphasize geographic diversification across Latin America, Eastern Europe and Asia.
S&P: What are some of the fund’s other significant data?
CEVA: The fund’s average duration is about 6.2 years. and the average maturity is 13 years. However, we can invest without regard to duration or maturity.
S&P: What about credit quality?
CEVA: The fund’s average credit quality is BB+. One cannot think of all emerging market debt as below investment grade anymore — that’s a thing of the past. A number of emerging markets, including Malaysia, Mexico, South Korea, Chile, South Africa and Poland, have had their sovereign debt upgraded in recent years to investment grade.
For example, Mexico, which is the largest country by allocation in virtually all emerging market bond indexes, has a relatively high rating of BBB. Our fund’s average credit quality is typically higher than that of most emerging market indexes because we seek to avoid distressed-credit or nonrated countries like Nigeria and Ivory Coast.
S&P: What are the fund’s top country allocations?
CEVA: As of March 31: Russia, 19%; Mexico, 17%; Malaysia, 8%; Peru, 7%; Brazil, 7%; Bulgaria, 6%; Colombia, 6%; Philippines, 5%; Panama, 5%; Romania, 5%; Ukraine, 4% and South Africa, 4%.
As a risk-control measure, we typically will not permit any one country to account for more than 20% of the fund’s assets.
S&P: What is the fund’s sector breakdown?
CEVA: As of March 31: corporate, 11%; sovereign, 87%. We limit our exposure to corporate debt in the emerging markets to about 15% because the corporates in these countries often lack liquidity.
We purchase corporate debt in countries where we have confidence in their sovereign risk. Our corporates tend to reside in upper-tier, well-managed companies like Televisa in Mexico.
S&P: What benchmark do you use?
CEVA: While most emerging market bond funds use the J.P. Morgan EMBI Plus Index, we feel that index is too heavily concentrated in just three countries: Mexico, Brazil and Russia, which together represent more than 65% of the index.