Emerging-market bond funds face reckoning4 min read . Updated: 04 Sep 2020, 09:52 AM IST
Assets aimed at producing higher returns in good times can post outsize losses when things go wrong.
Emerging-markets bond funds are facing a reckoning as Covid-19 stresses economies across the globe, reminding investors that assets aimed at producing higher returns in good times can post outsize losses when things go wrong.
The Ashmore SICAV Emerging Markets Short Duration Fund has lost about 17% in the 12 months through the end of July, mostly because of bold bets on developing-market debt that paid well during steady periods of growth but that turned sour when economies fell into crisis.
The fund managed by London-based Ashmore Group has gone from being the fastest-growing EM debt fund tracked by Morningstar to the worst-performing, thanks principally to wagers that put almost 40% of the fund’s money into three countries—Argentina, Lebanon and Ecuador—which all have defaulted since March. A spokesperson for Ashmore declined to comment.
Some analysts worry those defaults and the resulting negotiations with creditors could be the first among many, as the coronavirus puts a burden on developed and emerging economies alike. Governments have been forced to spend vast amounts of cash to keep businesses and people afloat, exacerbating troubles for those already bloated with debt or struggling with political unrest.
That could hit investors who bought emerging-market funds from companies including Vanguard Group, Invesco and Fidelity.
At least one emerging-market country has reneged on its debt for the past eight years in a row, according to S&P Global, which rates more than 130 countries from Brazil to Togo. Argentina rattled markets by defaulting in 2019.
Ricardo Adrogué, head of Barings’s global sovereign debt and currencies group, said investors have little power to force countries to pay debt during times of crisis, when they must sometimes balance domestic politics against access to international markets.
“One very big difficulty is that increasingly countries pay the debts that they want to pay back," said Dr. Adrogué, an economist. “Argentina is proof of that."
The Barings Emerging Markets Debt Blended Total Return Fund has returned over 9% year to date, making it the top-performing fund in its Morningstar category.
The divergence in performance between funds such as Ashmore’s and Barings’s underscores the volatility of emerging-market investments. They tend to attract investors seeking faster growth and higher yields during expansions and are typically hit hard when the economy sours.
Ashmore advertises itself as an emerging-markets specialist and holds awards for bond picking in developing countries. Founded by the British billionaire Mark Coombs, the firm has seen its assets under management grow to $83.6 billion in June from $58.7 billion three years earlier, according to company filings.
“They tend to be quite aggressive in terms of their management style," said Hubert Lam, a London-based analyst at Bank of America.
More-conservative funds have done better in the tumultuous market environment. Vanguard’s emerging-market bond fund, which has roughly $750 million assets under management, has returned more than 8% year to date through the end of July, counting price changes and interest payments.
The Vanguard fund has from 2016 to 2019 posted returns averaging 3 percentage points higher than a JPMorgan Chase index tracked by emerging-market investors, according to data by Morningstar.
Dan Shaykevich, a senior portfolio manager at Vanguard, said the pandemic’s threat to global growth has exposed vulnerabilities in commodity-producing countries and forced investors to focus on fundamentals. “2020 has been an extraordinary year in emerging markets," said Mr. Shaykevich. “We’ve been able to capitalize on a theme and then rotate into the next one multiple times."
Emerging markets have boomed over the past 20 years, as years of low and even negative interest rates pushed investors to seek juicer returns outside major-economy bonds. Billions of dollars flowed into debt from countries such as Gabon, Vietnam and Chile.
The growth of JPMorgan’s widely followed EMBI Global Diversified Index shows the rapid expansion. In 1993, the index consisted of 14 countries, including Mexico, Argentina and Venezuela. As of the week ended Aug. 21, it included more than 70.
“As people went across the world looking for yield, fixed-income shops decided there was an opportunity," said Mike McGill, a senior portfolio manager in emerging-markets debt at Aviva Investors. “This has been going on because investors are getting nothing for Treasurys and bunds."
Countries took advantage of investors’ demand by borrowing, sending emerging-market debt to a recent $72.5 trillion, according to the Institute of International Finance. The Middle East and Africa recently joined the frenzy, with investors piling into oil-rich markets. Saudi Arabia, added to the JPMorgan index in 2018, now holds a 3.89% weighting, in the top five highest as of Aug. 21, with China, Mexico, Indonesia and Qatar.
For some seasoned emerging-market traders, the high demand for riskier deals in recent years has been a warning sign. Ghana issued $3 billion of bonds in February. Order books at banks selling the debt were overflowing with clients requesting to buy around $15 billion, even though the African country was at the start of an election year and uncertainty regarding budgets lingered.
Investors in 2017 snapped up Argentine bonds sold at a yield of 7.85% that were to come due in 100 years—despite the country’s track record of missing debt payments. The August restructuring deal with creditors reduced the maturity and value of the debt, leaving investors recovering something along the lines of 54.5 cents on the dollar.
Despite such cautionary tales, some investors said the rebound of countries including Taiwan and the Czech Republic shows the pandemic offers a chance to separate the winners and losers.
“There are countries that have done the right things over the past decade and those that haven’t, which are now in predicament," said Mr. McGill.
—Sam Goldfarb contributed to this article.
Write to Julia-Ambra Verlaine at Julia.Verlaine@wsj.com