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December 20, 2004 at 07:00 PM
Dec. 15, 2004 — After a powerful rise in 2003, emerging market bonds continued to deliver strong returns this year, supported by continued cash flow into the sector, moderate global interest rates, and a maturation of the asset class as more ‘emerging’ countries enjoy sovereign debt upgrades, including Turkey, Brazil and Russia.
Kristin Ceva and Brian Matthews, co-managers of the $29.9-million Payden Emerging Markets Bond Fund (PYEMX), have steered this portfolio to a 11.7% gain for the 12-month period ended November 30, nearly matching the 12.0% return for its benchmark, the EMBI Global Diversified Index. For the three-year period, the fund climbed 13.2% annualized, underperforming the benchmark, which gained 15.2%. The fund has low volatility relative to its peers, as well as lower portfolio turnover, making it a more conservative offering.
“Performance in 2003 was largely driven by high returns from bonds issued by the credit-distressed, CCC-rated countries, and by historic cash inflows into the asset class as a whole,” Ceva said. “In 2004, we have continued to see spreads tightening, though not as dramatically as in the prior year. Also, 2004 witnessed more volatility, including a sell-off in May prompted by concerns about rising interest rates in the U.S. However, once we realized that the Federal Reserve would boost rates at a modest pace, emerging markets bonds rebounded nicely.”
Ceva’s fund emphasizes high-quality bonds [the fund's average credit quality is BB] issued by countries with improving macroeconomic fundamentals, and reasonable political stability. As a result, she tends to avoid unstable, credit-distressed nations, which have outperformed higher-quality debt issuers in recent years.
The fund, which is up about 9.1% year-to-date through November, has not only benefited from continued strong performance in emerging giants Brazil (up 11%) and Russia (up 9.5%); but also from moving into some new territories: Turkey, investment-grade South Africa, and two B-rated Latin economies, Uruguay (up 29.5%), and Venezuela (up 21%).
Ceva attempts to keep a healthy geographic diversification. The portfolio is invested across 14 countries. As of Sept. 30, 2004, it had 55.5% of its assets invested in Latin America, 33.5% in Eastern Europe, and 8% in Asia. The allocations in Latin America and Eastern Europe represented significant overweights relative to the benchmark. Ceva has reduced her exposure to Asia, now an underweight position, citing a lack of investment opportunities as spreads there have tightened.
The fund remains dominated by three major countries: Brazil, Russia and Mexico, which together account for 52% of assets, versus 30.7% for the benchmark. “The Russian markets struggled a bit due to the turmoil surrounding bankrupt oil giant Yukos, but that was offset by the country’s sovereign debt receiving a series of upgrades,” Ceva said. “Soon, Russian debt will have investment-grade status from all the rating agencies. This will open up new opportunities for higher-grade investors to put more money there. The country’s economic fundamentals are pretty strong, with a healthy debt-to-GDPratio. Russia does, however, present some long-term concerns, namely the slow progress of structural reforms by President Vladimir Putin.”
