- Managing duration is less relevant today, a manager needs to also look at the currency and the interest rate differential
- Underweight Brazil and avoid the likes of Venezuela, preferring Romania, Vietnam and Namibia, while exposzed to Peru, Chile, Vietnam and Senegal
- It is equally important to focus on issuers that are capable of swimming against the tide during economic cycles when these are in a downturn
Jean-Philippe Donge, manager of the BL-Bond Emerging Markets Euro fund talks about the opportunities in bond investments.
Jean-Philippe, do bonds still offer investment opportunities, even at these low interest rates?
Jean-Philippe Donge (JPD): Certainly, although that depends above all on each investor's specific expectations. Investors looking for quality and wanting to protect themselves against deflationary trends will find protection in paper issued by the most creditworthy borrowers such as Germany and the United States. Investors looking for a better return, and therefore willing to accept higher risk, should look at other markets. Many emerging countries have made enormous progress in terms of growth in recent decades, as is confirmed by various indicators such as rising per capita income and a decline in poverty. That is the case for example of South Korea, where per capita GDP has risen from less than USD 1,000 in 1960 to almost USD 25,000 today, and also Mexico and Indonesia. Much depends therefore on the investor's particular profile. The fact remains that the bond segment still offers opportunities that combine capital protection, return and reduced volatility.
A cautious investor might nevertheless argue that many countries are facing significant problems and political crises, in spite of relatively interesting returns. How are these countries supposed to manage?
JPD: It is true that some of them are in a precarious position, but these countries have learnt from the crises of recent decades. Take for example the depreciation of the Thai baht and Argentina's sovereign default. In the wake of these events, the two countries involved reviewed their economic policies and in particular the exchange rate system applied to their economies.
The global financial system has been extremely fragile since the collapse of Lehman Brothers. In this context, international central banks have been set the challenge of saving their respective economies. The resulting measures, at times unconventional, have shored up all asset classes, including emerging market bonds. Some of these countries – more than others - have adopted rescue measures: unpegging their currencies, stockpiling currency reserves and setting inflation targets to name just a few. However, others have opted for the opposite direction, for example Brazil whose interest rate rises are struggling to deal with the fiscal slippage and curb inflationary pressures. As a result, the countries that took these sometimes brave and unpopular decisions are those that have best withstood the shocks.
What does your fund's investment method involve?
JPD: In the past, managing bond investments was primarily a matter of managing duration, but this approach is less relevant today. Our methodology is determined by a variety of both macroeconomic and geopolitical factors. My principal challenge as a fund manager consists in identifying top quality issuers, as well as the instruments and bond issues available for each of them. As a result we now base our investment decisions on three criteria, namely duration, the currency and the interest rate differential which reflects credit quality. Our analyses are based on the information sent to us by our external analysts, which include ratings agencies and international research organisations. We compare this information with our own convictions and the current situation. We do not track any indices.
BLI's fund managers always talk of "high quality stocks". What sort of companies are these exactly? Which sectors do you favour?
JPD: The BL-Bond Emerging Markets Euro fund does not use a benchmark. It tends to adopt an opportunistic approach and tries to fulfil our clients' expectations. Our preference is for government bonds, followed by corporate bonds. The political environment and the economic context affect our investment choices. We therefore tend to underweight countries such as Brazil and avoid the likes of Venezuela, preferring Romania, Vietnam and Namibia, for example. The countries chosen must meet our expectations and offer a positive outlook.
Has your investment method changed?
JPD: As previously mentioned, our investment management approach has changed to look beyond duration alone and more actively incorporate two new criteria: credit risk and exchange rates. Until about 15 years ago, very little distinction was made between issuers belonging to the same sector or “type”. For example, Greece was on an equal economic footing with Germany, because both countries belonged to the same monetary zone. Although, I admit that may be a bit of an exaggeration. The same was also true for Argentina and Mexico, because we treated emerging countries as a bloc, making no other distinction between them. However, 2001 and 2008 changed things. In 2001, we witnessed the biggest default until that time, namely that of Argentina. A distinction was made within the asset class for the first time and contagion remained limited. In 2008, one more event linked to another player deemed “too big to fail” took place: the Lehman Brothers collapse. Around these two events and over the course of time, significant differences emerged within both the sovereign and corporate bond segments. For example, post-Lehman crisis, the markets understood that General Motors and Ford were not one and the same. The former was declared bankrupt and then nationalised in 2009. Our investment method has incorporated this reality by pursuing further discernment between the various issuers, whatever the sector or economic region under consideration.
You just mentioned corporate debt. Tell us more about this segment and its contribution to your investment management.
JPD: Nowadays the differences are more marked than in the past. Regardless of the quality of the companies identified, it is equally important to focus on issuers that are capable of swimming against the tide during economic cycles when these are in a downturn. I have in mind in particular the telecommunications sector, where certain companies in emerging countries have succeeded in joining the ranks of multinationals. That is the case for example of Hutchison Whampoa in Hong Kong, Singapore Telecommunications in Singapore, Bharti Airtel in India and América Móvil in Mexico. These companies are generally better placed to offer a higher return than the average of their developed country counterparts, which are in some cases highly leveraged. However, I wouldn't rule out any sector from the outset. In other words, because we include more credit risk, it is fair to say that our investment approach is flexible, opportunistic and responsive.
Do you also invest in currencies other than the portfolio's reference currency?
JPD: Yes, we do. We have been investing in debt securities denominated in local currencies for over ten years. The local debt market generates better returns than those of most eurozone countries. The challenge lies in identifying markets and currencies that offer a degree of stability over an indefinite period, in addition to a higher return. This approach is obviously opportunistic, even when our decisions are based on firm convictions. That was true for the Brazilian real in the 2000s, and is true today for the Indian rupee. We have suffered a few disappointments, though, especially with the Mexican peso. In all cases our decisions are based on in-depth analysis of the economic and political environment.
The BL-Bond Emerging Markets Euro fund has been in existence for just over two years and has delivered a performance of over 11% since its inception. How do you see its future development?
JPD: The BL-Bond Emerging Markets Euro fund does not represent the 20 best European economies. What it does is exploit the potential offered by over a hundred economies worldwide. As these economies and their political systems have nothing in common, we are talking about a diverse universe that throws up numerous opportunities. Our principal challenge consists in juggling endogenous and exogenous factors, including regional influences.
Are you not concerned that the fund could be hit by a new emerging market crisis? How can you protect the fund from this?
JPD: Not all countries are going to go bankrupt or declare war. Likewise, they are not all oil exporters and often have very different levels of debt and currency reserves. I have therefore set myself the task of relentlessly seeking out any investment opportunities that may come up. What sets us apart from the competition is our consistent interpretation and processing of information relating to each individual country, and the convictions and opinions that we forge for the management of our fund. I believe that this characteristic enables the BL-Bond Emerging Markets Euro fund to stand out in any circumstances.
What is the outlook and how do you expect the fund to develop?
JPD: I am optimistic going forward. There will always be corrections, and no sector is immune. That is why the fund is intended in particular for investors with a medium to long-term investment horizon. Peru, Chile, Vietnam and Senegal are countries that didn't even appear on the radar of our clients 15 years ago. But they are an integral part of the portfolio now, because they all boast positive growth indices, falling poverty levels and improving education systems, among other indicators. I therefore believe that the BL-Bond Emerging Markets Euro fund, like its twin the BL-Bond Emerging Markets Dollar fund, successfully covers this broad spectrum and is the best adapted to this type of investment. There are nevertheless certain differences between these two portfolios. The first invests in both euro-denominated and local currency issues, whereas the second, launched six months ago, targets a broader basket of sovereign issuers while limiting itself almost exclusively to dollar-denominated debt.