Lombard Odier Investment Management, which oversees about $200 billion globally, is considering starting a new fund that will buy local debt in developing nations after their currencies surged to a 17-month high.
The Geneva-based money manager will favor securities that are less vulnerable to inflation, including those with either shorter maturities or floating interest rates, according to Deputy Global Chief Investment Officer Stephane Monier. Price pressures in emerging economies are rising, he said, as monetary easing in advanced nations fuels investment in higher-yielding assets.
Bond funds dedicated to developing markets attracted $1.1 billion of inflows in the week ended Feb. 13, after taking in $1.3 billion in the previous week, Morgan Stanley said in a Feb. 15 report, citing data from research firm EPFR Global. The JPMorgan ELMI+ Index of emerging-market currencies has rallied almost 9 percent from a five-month low in June and touched the highest level since September 2011 this month.
“Over the long run, their currencies have to appreciate,” Monier said in a Feb. 20 interview in Hong Kong. “We are trying to study the possibility of making a fund that will buy emerging-market local currency but with less duration exposure.”
The plan may include investing “more in monetary instruments, short-term floating-rate notes, and maybe inflation-protected securities when they are available,” he said.
The relatively high yields on emerging-market debt are also attracting investors. The JPMorgan GBI-EM Global Diversified Composite Index puts the average yield on local-currency bonds at 5.47 percent, versus 0.73 percent for Japan’s 10-year government notes, 1.6 percent in Germany and 1.98 percent for the U.S., according to data compiled by Bloomberg.
The JPMorgan ELMI+ currencies index has gained 0.1 percent since the Group of 20 nations pledged in a Feb. 16 statement not to “target our exchange rates for competitive purposes,” while refraining from singling out Japan for weakening its currency. The yen has weakened 7.9 percent against the dollar this year as Prime Minister Shinzo Abe called for unlimited money printing to spur growth. Central banks in the U.S. and Europe have also eased monetary policy.
“The central banks of the developed world are pumping as much money as they can to prop up their own economies,” said Monier. Some of that cash was re-invested in emerging markets, he said.
Those inflows will drive developing-nation currencies higher even as policy makers intervene to narrow fluctuations, according to Monier.
Taiwan’s central bank said last month that it would intervene in the market should “irregular factors,” such as large fund flows, cause excessive volatility. Brazil sold reverse currency-swap contracts Feb. 15 for the second time this month to contain the real’s appreciation.
“Typically, central banks and governments would intervene when the speed of appreciation is such that it doesn’t allow the economy to readjust to a new level,” said Monier.
Inflation in Asia and the Middle East will be 4 percent and 4.2 percent in 2013, respectively, according to median forecasts in Bloomberg surveys. Consumer prices at the Group of 10 nations including the U.S., Japan and some European nations will climb 1.6 percent, according to separate surveys.
Investors should be aware of the risk of rising private debt levels in emerging markets as price pressures increase, said Monier.
“Where we see a large dichotomy of the world right now is on the inflation front,” he said. “It’s quite striking, in Europe, with the exception of the U.K. at the time, we don’t see any inflationary pressure. But when you travel to the emerging markets, the Middle East or Asia, you see buildings are propping up in every corner. From a global perspective, what I’m a little bit worried about is inflation.”