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Big Bond Funds Diverge on Emerging Markets – CEFA Commentary

by on February 28, 2012

By: George Cole Scott
President & Sr. Portfolio Manager
Closed-End Fund Advisors

Some of the world’s biggest bond-fund managers disagree on the future of the $2.3 trillion market for emerging markets debt, continuing the debate over the European crisis’s impact on global growth.

Legg Mason’s Western Asset’ s funds and AllianceBernstein Holdings have dialed back their exposure to emerging markets bonds in their respective portfolios. Closed-End Fund Advisors, uses Western Asset Emerging Markets Debt Fund (ESD: NYSE) in our portfolios, which has been a market-breaking performer, especially since year-end.

Emerging-market bond funds have been among investors favorites since 2009 as investors have poured $2.9 million into the funds, according to Morningstar. In 2011 alone, net inflows into mutual funds have increased $12.5 billion, up 380% from a net $2.6 billion two years earlier, a staggering sum in what may be an overheated market.

Other investment management firms also plan to reduce exposure to emerging markets over the short term, while Pimco has already reduced its exposure in its flagship $250 billion Total Return Fund, a mutual fund.

Pimco has been one of those investors fretting that euro-zone debt problems would drag on for years, damping global growth and souring investors’ sentiment in riskier assets such as emerging markets debt. Pimco has also raised concern about the health of China’s economy.

The influx of cash into emerging-market debt doesn’t appear to be slowing: The net cash inflow into the space in January, up 72% from the previous January, according to Morningstar. Whether investors’ passions will continue appears to hinge on their feelings toward the euro-zone crisis.

So far in 2012, emerging markets bond funds have posted a 6.5% gain, outpacing all but one other fixed income category, with an annualized three year return of 19%, more than double the categories’ 7.6% five year return.

Western Asset sees the most opportunities now in Latin America, followed by Asia and Brazil and Indonesia in particular saying “the farther you are away from Europe the better”.

However, not all bond managers are wary of Europe: Michael Hasenstab, with $59.6 billion in assets under management, runs Franklin Templeton Investments’ flagship Templeton Global Bond Fund as well as closed-end Templeton Emerging Markets Debt Fund (TEI:NYSE). He says he believes some of the stability measures taken recently are “significant enough to prevent even a disorderly default or Greece exit from cascading” into Spain or Italy.

Even if Greece were to default, a scenario that seems less likely after European officials reached a fresh bailout for the debt strapped nation recently. Mr. Hasenstab said a systemic risk in Europe could be prevented. He has been buying government bonds in South Korea, Malaysia, and Australia, along with purchases in Polish government bonds. These four markets constitute the biggest shares in his funds.

Other money managers have been reducing exposure to emerging markets in part because they see better opportunities available –in U.S. corporate bonds, for example. Closed-End Fund Advisors agrees with this scenario, especially when a fund trades at a premium to its net asset value and there are better opportunities available.

Source: The Wall Street Journal.

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