“We are committed to seek risk assets, and earn returns from high coupons and long duration, but it is important not to be afraid of de-risking,” London-based Christopher Watson, portfolio manager at Finisterre Capital, told FSA during a recent visit to Hong Kong.
Finisterre has been majority-owned by Principal Financial Group since 2011. Watson co-manages the flagship Principal GIF Finisterre Unconstrained Emerging Markets Fixed Income Fund, which targets an annual total return of 5%-9%, of which two-thirds is typically earned from income.
Christopher Watson, Finisterre Capital
“Last year started well for emerging market bonds, but global liquidity conditions deteriorated sharply by the fourth quarter as the US Federal Reserve’s interest rate narrative became hawkish,” he said.
“We made a strategic decision early in the year to position the fund more cautiously.”
Allocation to cash and equivalent assets was raised to around 50% of the portfolio, which meant that the value of the fund was stable while other emerging market bond funds suffered throughout the summer and into the autumn. (see chart below)
According to Watson, he was able to off-load emerging market bond holdings — whose bid-offer spreads are typically wide — without detriment to the fund performance.
“Towards the end of the fourth quarter we began to re-risk the portfolio by taking on more credit exposure, which played out well during the first three months of this year as liquidity conditions improved and the Fed shifted to a dovish stance.”
Subsequently, in another reversal, the fund has reduced risk exposure after the sharp correction which has seen absolute yields fall about 70 basis points (bps) and spreads narrow a further 70bps.
Watson calls this move a “tactical decision”, in contrast to the “strategic decision” he and co-manager Damien Buchet made last year to reduce emerging market exposure. Cash and equivalents now amount to approximately 25% of the fund, which they are marketing to private banks in Asia.
Macro concerns over?
Yet, the major macro-concerns that shook asset prices last year — namely the Sino-US trade dispute and a series of US interest hikes — have subsided as dominating factors, argued Watson. He reckons that China and the US will reach an agreement, while the spectre of higher interest rates has been removed as the US economy enters the final stage of its economic cycle.
He believes that the outlook for emerging market growth is generally positive, and highlighted the various stimulus packages in China that should support economic activity in the rest of Asia, and also the encouraging long-term trajectory of growth in India, despite the uncertainty of the current elections.
On the other hand, “Russia is unremarkable” and “Brazil will do less well, but better than last year,” he said.
The fund retains a few curious credits, despite the apparent agility of the managers’ timing. As at the end of March 2019, it had a 2.83% weighting in an 1MDB (the scandal-ridden Malaysian investment fund) bond issue and 2.74% weighting to ESAL Gmbh, a subsidiary of Brazilian meat processing giant JBS which is majority-owned by the Batista family, who have been implicated in Brazil’s long-running corruption saga.
The fund also has holdings in the local debt markets of Egypt, Russia and also has a two-year position in Peru, which Watson considers a mining economy with a similar dynamic to an emerging Asian economy. In Asia itself, the fund has exposure to Indonesia and Malaysia where Watson is sanguine about the macroeconomic prospects.
In general, local currency emerging market debt has performed poorly from an international investor perspective since the rise of the US dollar since July 2011. Any positive returns have typically been offset by currency depreciation, according to Watson.
“However, emerging market foreign exchange rates [against the dollar] are at their cheapest levels for a long time. We have some exposure, but need more convincing signals of sustainable global growth to be fully committed,” he added.
Principal GIF Finisterre Unconstrained Emerging Markets Fixed Income Fund vs emerging market fixed income sector average