Top Bond Buyers Are Pivoting From Best Emerging-Market Picks

  • Cameroon, Mongolia leading emerging-market dollar bond returns
  • Notes from Gulf and Andean nations among worst performers

Morris, O'Sullivan on the Global Bond Market

Emerging-market investors who cherry picked the best bonds in the first six months of the year are changing tack for the second half.

AllianceBernstein LP, Ashmore Group Plc and other money managers who piled into debt from places like Cameroon, Mongolia and Costa Rica -- earning outsized returns amid rallies in those countries -- are now seeing better value in nations such as Turkey, Ukraine and Ecuador.

Ashmore funds benefited from owning all of the top 10 sovereigns in the first half of the year, including overweight positions in Mongolia and Zambia. But now “most of those trades are behind us,” said Jan Dehn, the head of research at the London-based investment manager, whose $1 billion Emerging Markets Total Return Fund has outperformed 94 percent of peers in the past year, according to data compiled by Bloomberg.

Dehn now favors creditors from oil exporters in Central Asia and Latin America, which were among the worst performers to start the year as crude dropped almost 15 percent. In doing so, he’s pivoting from Cameroon and Mongolia, which were boosted by multilateral aid packages, as well as Costa Rica.

“Most of the oil credits are going to survive,” he said. “They trade at distressed spreads, but they will survive, so they are a good yield play.”

Here are some of the other second-half picks by money managers who’ve gotten it right in 2017:

Turkey

  • 1H total return: 8.9% (10th out of 69 developing nations)

After profiting from long bets on Mongolia, Cameroon, Ethiopia, the Dominican Republic and Turkey, AllianceBernstein portfolio manager Christian DiClementi is shaking things up. He’s reduced debt holdings in all of those nations aside from Turkey, where he says bonds remain cheap after suffering losses last year amid a military coup attempt against President Recep Tayyip Erdogan and questions about the central bank’s credibility.

Carl Ross, a sovereign debt analyst at Grantham Mayo Van Otterloo & Co., also has a small overweight in Turkish notes. The firm’s developing-nation bond fund has topped 94 percent of peers in the last year, Bloomberg data show.

“Erdogan may want to boost spending, but overall he realizes the importance of that fiscal anchor to the ratings agencies,” Ross said.

Argentina

  • 1H total return: 2.1% (64th out of 69 developing nations)

Argentina, the poster-child of Latin America’s receding populism, is another favorite of DiClementi, who oversees portfolios including a $1.2 billion emerging-market debt fund that’s bested 81 percent of peers this year. While its corporate bonds posted the third-highest returns to start the year, the nation’s sovereign hard-currency notes were a hit-and-miss.

That could change in the second half as the AllianceBernstein money manager expects mid-term elections in October to reaffirm President Mauricio Macri’s mandate for structural changes to the economy. Argentina is also favored by Bent Lystbaek, a money manager at Danske Capital in Lyngby, Denmark, who oversees the firm’s emerging-market debt fund that’s topped 83 percent of peers this year from bets including Mongolia and Turkey.

Venezuela

  • 1H total return: 4.2% (47th out of 69 developing nations)

Venezuela’s dollar bonds returned a world-leading 52 percent last year, but labored through the first half of 2017 as reserves hit a 15-year low, forcing the government to turn to Wall Street for creative financing. Still, the notes offer more yield than any other emerging-market sovereign and avoiding the debt makes it tough to beat the benchmark.

Dehn said investors will continue to profit by scooping up bonds from the government and state oil company Petroleos de Venezuela ahead of payments and taking profit afterward.

“It’s a pretty big decision to sell when bonds are priced at 40 cents on the dollar,” said Grantham Mayo’s Ross, adding that Venezuela remains one of their top holdings. “You have to really take a position that it’s going to be a nasty restructuring to do that.”

Ukraine, Ecuador

  • Ukraine 1H total return: 7.7% (16th out of 69 developing nations)
  • Ecuador 1H total return: 2.2% (63rd out of 69 developing nations)

Outside of Venezuela, Ukraine and Ecuador bonds offer the highest yield by most measures, which puts them among DiClementi’s top three picks. Lystbaek also says the Eastern European nation’s notes are cheap.

Investors may be overestimating the political risk in Ecuador, according to Anders Faergemann, a senior fund manager in London at PineBridge Investments who oversees a local-currency bond fund that beat 83 percent of peers in the first half. Recently-elected President Lenin Moreno, a former vice president to socialist leader Rafael Correa, lacks the political capital to implement more radical policies and may steer the nation’s economy to a more business-friendly environment than expected, Faergemann said.

And while Ecuador bonds would likely rally with an uptick in crude, they’re less vulnerable to a drop in prices than most other bonds from oil-dependent nations, according to DiClementi.

The risk premium on emerging-market sovereign bonds was unchanged at 316 basis points as of 12:19 p.m. in New York Friday, according to JPMorgan Chase & Co. indexes.

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