Fidelity to DoubleLine Dodge Currencies: Riskless ReturnCharles Stein
Fidelity Investments’ John Carlson and DoubleLine Capital LP’s Luz Padilla pursue different strategies in their emerging-market debt funds. One thing they have in common is buying bonds denominated in U.S. dollars.
That decision enabled them to sidestep 2013’s slide in developing-country currencies and turn in the best risk-adjusted performance among U.S. emerging-market bond funds over the past three years, according to the BLOOMBERG RISKLESS RETURN RANKING. Funds that owned local-currency bonds, including the biggest in the peer group, the $10.7 billion Pimco Emerging Local Bond Fund, wound up near the bottom of the list.
The Federal Reserve’s signal in May that it would scale back its bond-buying program sent emerging-market currencies tumbling on fears that investors would shift money away from developing nations. The decline was exacerbated later in the year by concern that China’s economy was slowing and by political turmoil in countries from Argentina to Turkey to Ukraine.
“A few years ago I was constantly getting pressure from investors to put money into currencies,” Padilla, manager of the $500 million DoubleLine Emerging Markets Fixed Income Fund, said in a telephone interview from Los Angeles. “We just didn’t think the potential return was commensurate with the risk.”
Bloomberg’s index tracking dollar-denominated debt from emerging countries returned an annualized 6.6 percent in the three years ended Feb. 24, compared with 2.7 percent for a barometer of local-currency bonds.
Companies including Los Angeles-based TCW Group Inc. and Boston-based MFS Investment Management created funds dedicated to local-currency bonds in recent years to take advantage of growing interest in the category. Investors poured $5.2 billion into the Pimco Emerging Local Bond Fund in the three years ended Jan. 31, the most collected by any fund in the group, according to estimates from Chicago-based Morningstar Inc.
“People were looking for diversification and greater returns,” Karin Anderson, a Morningstar analyst, said in a telephone interview. “More recently they’ve seen the downside currencies can inflict.”
Bloomberg’s risk-adjusted return is calculated by dividing total return by volatility, or the degree of daily price-swing variation, giving a measure of income per unit risk. The returns aren’t annualized.
Carlson’s $4.3 billion Fidelity New Markets Income Fund had a risk-adjusted gain of 4.5 percent in the three years ended Feb. 24. The fund, with less than 5 percent of holdings in local-currency bonds as of Dec. 31, had the second-highest absolute return and lower-than-average volatility in a group of 27 emerging-market bond funds with at least $250 million in assets.
The DoubleLine emerging-markets fund, with no local-currency bonds, gained a risk-adjusted 4.3 percent by combining above-average returns and the lowest volatility.
Padilla, 46, joined TCW in 1994 and became co-manager of its emerging-market bond fund in 2001. She was lead manager of the fund from October 2006 to December 2009 as it outperformed 99 percent of peers, according to Morningstar. She moved to DoubleLine in December 2009 when Jeffrey Gundlach founded the firm after being fired from TCW in a dispute.
Padilla, unlike Carlson, has long favored corporate bonds over government securities, saying they are a better way to benefit from the improving economic fundamentals of developing countries. Her fund had 83 percent of its assets in corporate debt as of Jan. 31, and 14 percent in quasi-sovereigns, or bonds from state-run companies such as Russia’s Gazprom OAO.
The manager said she began hearing in 2010 from central bankers in the developing world who believed their currencies had become overvalued after rallying from market lows in March 2009. Concluding that potential appreciation of the currencies was limited, she decided to stick to dollar-denominated debt. Over the past three years, the Argentine peso dropped 49 percent, the Brazilian real 29 percent and the Turkish lira 27 percent against the U.S. dollar.
Her fund is heavily concentrated in Latin America, with no exposure to the troubled economies of Argentina and Venezuela, whose dollar-denominated bonds fell 11 percent and 9.9 percent this year through Feb. 24, according to data compiled by Bloomberg. In Venezuela, the government of President Nicolas Maduro has been battling street protests since early this month. In Argentina, consumer prices surged 3.7 percent in January, the most in more than a decade.
“Why would I want to put our investors’ money at risk?” Padilla said of her decision to avoid both countries. “I would rather not do that, even if sometimes I may be leaving money on the table.”
Carlson, by contrast, has often made Venezuelan debt the largest holding in his fund. Venezuelan bonds represented 15 percent of the Fidelity New Markets Income Fund at the end of 2011 and 13 percent at the end of 2012, according to regulatory filings. The bonds returned 15 percent in 2011 and 38 percent the next year, according to data compiled by Bloomberg.
Asked about Venezuela in an April 2013 interview with Forbes Magazine, Carlson said: “There are two questions. Do they have the ability to pay? Do they have a willingness to pay?”
Carlson cut Venezuelan debt to 7.8 percent as of Dec. 31, data from the Fidelity website show. He reduced Turkish debt to 3.3 percent from 8.4 percent at end of 2012. Turkey’s dollar-denominated debt fell 13 percent last year, according to data compiled by Bloomberg.
Carlson, 63, was traveling and unavailable to comment, said Charles Keller, a spokesman for Boston-based Fidelity Investments.
Carlson, who has run the fund since 1995, has beaten at least 84 percent of peers over the past 5 and 10 years, according to Morningstar, which named him fixed-income manager of the year for 2011.
He concentrates his holdings in sovereign debt, seeking to identify countries “that are not well understood and that we believe offer significant upside potential,” Fidelity wrote in its fourth-quarter performance review.
The manager can have as much as 20 percent of the fund in local currency debt, a self-imposed limit rather than a prospectus rule.
“While local-currency emerging-markets bonds have become all the rage in recent years, veteran manager John Carlson is determined to stick to dollar-denominated debt,” Morningstar analyst Kevin McDevitt wrote in a 2011 note.
Paul Denoon, who oversees $29 billion of emerging-market debt at New York-based AllianceBernstein Holding LP, said the selloff in local-currency bonds has gotten too extreme.
“It has gone way beyond the fundamentals,” said Denoon, who is using the opportunity to add exposure to the bonds across a number of portfolios.
Mutual funds tend to concentrate in dollar- or local-denominated debt, although managers often have the option of moving between the two when they see opportunities. At the $4.9 billion TCW Emerging Markets Income Fund, local-currency bonds have ranged from zero to one-third of the holdings, David Robbins, one of the managers, said in a telephone interview.
Given the drop in emerging-market currencies, the local debt will become the more compelling asset class at some point, he said. Robbins’s fund had 95 percent of its assets in dollars as of Jan. 31, according to the TCW website.
Padilla said the risk still outweighs the reward.
“We continue to look at local currency, but we aren’t quite there yet,” she said.