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Fair exchange

Joanne Ellul reports that fund managers see emerging market currencies as a way of controlling the potential volatility of investment risk in bonds

Fund firms are increasingly turning to currency as a way to manage the risk of investing in emerging markets.

Henderson is to launch an emerging markets currency fund in the third quarter while Investec last week launched an investment-grade emerging market debt fund for Peter Eerdmans, joining a number of other offerings in the retail sector.

Emerging market currencies tend to appreciate in an environment of growth and inflation, in the expectation of higher interest rates. This positive relationship in currencies does not hold in emerging market bonds, which fall in value when interest rates rise.

However, currency appreciation can be used to reduce the risk of lower returns from bonds in emerging market debt funds and currencies can be traded themselves in a fund to achieve returns.

Henderson head of global currency Bob Arends says: “The global currency market is the most liquid in the world, with average turnover now $4 trillion, 60 times that of the equity market, which means that currency is inexpensive to trade.”

The new Investec fund will take between 10 and 20 active long and short positions in investment grade emerging markets sovereign bonds denominated in local emerging market currencies.

Investec head of emerging market debt Peter Eedermans says: “The investment-grade local emerging market debt fund offers a slightly more conservative version of our established local emerging market debt strategy. As such, it allows access to this exciting asset class for more conservative investors, those who perhaps want to take a first step and will feel comforted by investmentgrade ratings assigned by the rating agencies.”

Investec head of currency Thanos Papasavvas says: “The emerging markets currencies are not a homogenous set of currencies with differences in fiscal policy, interest rates and currency appreciation across different regions. Developed world currencies move in line with one another.”

This flexibility is important, says Papasavvas, as if fiscal tightening controls the currency in China, then there are other areas such as Korea, he can switch to. He also says debt levels in the developed world cast doubt over the traditional notion that such currencies are a safe haven that investors can flock to in unstable times.

Papasavvas says: “The dollar will be on the back foot over the next three years. Emerging markets currencies will benefit, but that does not mean that you must invest in all the high-yielding currencies to benefit from dollar depreciation. The important thing is to have a spread of currencies.”

“The developed countries which are presumed to be stable are amid debt risks, such as the contagion from Greece,” he says.

Barings Asset Management Thanasis Petronikolos, manager of the £103.9m Baring emerging markets debt local currency fund, says: “High interest rates are supportive of emerging market currencies. Holding such a fund means that investors get three sources of returns by holding the bond, capital gains in the bond market if the yields come down and returns from currency appreciation.”

Alexander Kozhemiakin, head of Standish Mellon’s EMD team, says three-quarters of its £6.9bn of emerging market debt portfolios is in local emerging market currency. He manages the £2.5bn BNY Mellon emerging market debt local currency fund. He says: “Most UK investors focus on developed markets. Of the £1.2bn that has flowed into the fund over the last two years, a fifth has come from retail. Now retail is discovering the emerging market asset class.

“I expect 10 per cent returns from the fund in US dollars this year, which is not that bad in a lowinterest-rate environment.”

Kozhemiakin says there are more foreign developed currencies flowing into emerging markets than flowing out and this has caused appreciation of the emerging market currency. “The growth differentials between fast growing emerging markets and slower developed ones act as a magnet for capital,” he adds.

He says that emerging market countries such as Malaysia and Chile have purely investment-grade bond risks. “So what risk you are taking on is the interest rate risk and the currency risk but is a good addition to a well diversified portfolio,” says Kozhemiakin.

“Would you rather invest in US treasuries that are artificially supported by political actions like quantitative easing or invest in emerging markets where monetary authorities are intervening to control currency appreciation. This reduces volatility for the long-term investor.”

“We reduced the currency risk in the portfolio a month and a half ago in anticipation of a rise in risk aversion. That has done well. We have reduced our overweight exposure to the Russian rouble, the euro-based currencies and added to our underweight position in the South African rand and Brazilian real. I am looking for opportunities to buy Malaysian ringgit and Mexican peso.”

Bestinvest senior analyst Ben Seager-Scott says: “If you look at yields, you are swapping investment-grade bonds for high yield in developed markets, so investing in emerging market bonds is a way of diversifying high-risk bond exposure.”

However, Seager-Scott cautions that emerging markets currency funds rely on currency appreciation, which is not certain.

He says: “You have to take on currency risk. If we get risk aversion, with some black swan event or a global crisis, then money will flow into safe havens. Emerging market currencies can go down.

“Political risks exist in emerging markets, as seen in the Middle East. They are less stable than developed markets.”


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