Emerging market bonds are a potentially profitable addition to fixed-income portfolios

The debt-to-GDP ratios in emerging markets are considerably better than in many developed markets

I’ve spoken before about the need for income investors to diversify their income portfolios. Simply put, the “set it and forget it” portfolio of government bonds looks like an increasingly risky proposition these days.

One solution to this problem is emerging markets. Emerging market (EM) bonds have recently become an asset class that high net worth individuals (HNWIs) have started to become very interested in. As developed markets (DMs) struggle to get their fiscal houses in order, emerging economies are expanding. As a result, the debt-to-GDP ratios in emerging markets are considerably better than in many developed markets.

I recently spoke with Bart Turtleboom, portfolio manager and co-head of emerging markets at MAN GLG. The company is the world’s largest publicly traded hedge/alternative money manager. It’s based in the U.K. and has about $60 billion under management. Turtleboom has been an EM analyst and manager for almost 15 years – long before EM bonds became a popular asset class. Before that, he worked for the International Monetary Fund. Suffice it to say, when it comes to emerging markets, he is one of the most insightful investment professionals I’ve ever spoken to.

“The fixed income markets in many emerging markets have deepened significantly over the last 10 years,” Turtleboom told me. “Not only has demand increased beyond a few big DM funds, the sophistication and unmet need from locals as they build and diversify their own portfolios has also fuelled a more liquid, transparent and tradable market.”

Turtleboom believes EMs are a pretty good place to invest.

“Most EM sovereign balance sheets look currently superior to the average DM country… EMs [also] often have further potential due to better demographics, access to commodities, etc.”

I also asked Turtleboom about currencies. “We see [currencies] as a separate asset class, deserving an active decision to hedge. Too many times we see in the market that the majority return of an equity manager is derived from [currencies] rather than from security selection.”

If you’re interested in exploring the world of EM bonds, here are a few quick tips, based on strategies used by Turtleboom and the HNWIs I know.

Diversify, diversify, diversify

This is not the place for all-in bets. Despite their improving financial profile, EMs carry a good deal of risk. Over the past several decades, there have been several EMs that have defaulted on their debts, including Argentina in 2002, Russia in 1997 and Mexico in 1982. Diversification should be a top priority.

Consider currencies

I’m with Turtleboom on this one. Investing in EMs is difficult enough; leave currency for the speculators and pick a product that allows you to hedge back to a major currency (USD or CAD).

Think about active management

Over the past several years, there have been a number of low-cost exchange-traded funds that invest in EM bonds; many of these can be excellent investments. But EMs are one area where imperfect/incomplete/inaccurate information is a real danger. For that reason, it makes sense to work with a pro in this space. You’ll pay more in fees, but this is one area where you don’t want to be penny wise and pound foolish.

Complement, not replace

EM bonds can be more volatile than government bonds from Canada, the U.S. or other developed nations. For that reason, they should be considered a diversification tool and an attractive way to add some alpha to the overall portfolio. •

Thane Stenner (thane.stenner@richardsongmp.com) is the founder of Stenner Investment Partners within Richardson GMP Ltd. His column appears every two weeks.

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