Not allocating to emerging market (EM) bonds represents a “lost opportunity” given the meaningful spread pick-up versus developed markets, according to Pongtharin Sapayanon (pictured), head of fixed income and asset allocation at abrdn Investments (Thailand).
Allocating more to emerging markets is becoming an increasingly popular approach as while investment grade and high yield credit spreads across the US and Europe are trading at historically tight levels, EM corporate spreads are trading within their long-term averages.
At the same time, the opportunity set for allocating to EM is growing as the market capitalisation of the JP Morgan Emerging Market Corporate Index has been growing significantly, while a number of those issuers have done a good job of strengthening their balance sheets recently.
Last year, abrdn launched the Short-Dated Enhanced Income (SDEI) strategy, an active, diversified, global fixed income solution, which is designed to offer compelling yield combined with low credit and duration risk.
Compared with a lot of similar short-dated income strategies, SDEI allocates more to emerging markets, which Sapayanon notes has been yielding fruit as investors seek higher yield without wanting to sacrifice on risk.
“You will see there’s a meaningful pick-up in spreads if you move into EM. It’s not like you’re giving up a lot in terms of corporate strength either. I think for some of them it’s even on par or higher than some of the developed market issuers. And so in a way we feel it’s a lost opportunity if we don’t include this universe into this fund,” he said.
Clear guardrails
The timing of the launch of the strategy last year was near perfect as interest rates had peaked, while the expectation is that the next move by the Federal Reserve will be to lower rates, which should see more investors willing so shift their focus away from money market funds.
Sapayanon is quick to point out though that the strategy is not designed to be not simply a cash plus strategy, but one that is able to provide a compelling offering to clients regardless of the market cycle.
“When we were thinking about launching this fund obviously we reached out to various clients from retail to institutional and we found that no matter what the interest rate cycle is, even when it’s zero or it’s five, there is always a natural demand for more than just money markets. There is this space between one to three years that wholesale distributors as well as retail investors are looking to invest their excess cash,” he said.
As mentioned, the strategy allocates more to EM than many of its peers, although allocations to developed markets are at least 40%. This is in part to mitigate against the greater volatility associated with EM credit.
The strategy also caps its exposure to high yield at 20% and targets an overall credit rating of A-. From a duration perspective, they have the scope to go up to five years, although they need to keep duration overall in the portfolio to less than two years.
Unusually, for a non-money market strategy, it offers a T+1 settlement, which means that a large proportion of the strategy is invested in Treasuries to provide that liquidity buffer. Overall, the strategy is targeting a return of SOFR plus 175bp to 225bp.
Strategy benefits
The strategy has obviously benefited from the timing of the interest rate cycle as well as the fact that the yield curve is currently inverted, which means that there are less compelling reasons for investors to take on duration risk.
Regardless of the timing of its launch, one of the key strengths of the strategy is its simplicity given the fact that the overall duration of the strategy is so short.
“One of the reasons why we have positive feedback from this fund compared to other more generic global aggregate funds is with a global aggregate fund when we try to describe the historical performance to clients and explain to them what we foresee over the next six to 12 months, it’s complicated,” said Sapayanon.
“You’ve got the yield curve, you’ve got spread movements, maybe some currency overlays and sometimes clients don’t understand what will happen. But when we launched this fund, it’s a lot easier to explain. They understand the risk because it’s short dated in nature. They know if they cut, the yield will go down and the price will go up. If they hike this will happen.”
Sapayanon also pointed out that another key advantage of the strategy is the fact that a lot of local clients tend not to have much US dollar exposure and by investing into this strategy, they are diversifying their currency exposure and reducing the overall risk in their portfolio.
“What we like about having dollar exposure in your portfolio over the long run is that it reduces your risk quite meaningfully i.e. it increases your Sharpe ratio. That’s the story we’re trying to deliver to our clients,” he said.
“It’s good timing, you’re getting the yield you want, but the dollar is a big diversifying factor that clients overlook. I think clients in the past have been averse to having exposure to some currency risk, but it actually increases your risk-adjusted return meaningfully over the medium term.”
Pongtharin will be joining Fund Selector Asia at our flagship FSA Investment Forum Thailand on 12 September 2024 where he will be presenting Capturing fixed income opportunities when central banks ease.
Find out more about his session and the event below.
