Hu is a portfolio manager on the team that manages the NN (L) Emerging Markets Debt Hard Currency Fund, which holds both sovereign and quasi-sovereign bonds.
Bonds from Ecuador, Egypt, Turkey, Uruguay, Russia and Argentina are among the top ten holdings, according to the factsheet (31 October). Turkey is the biggest country allocation at about 5%. According to FE data, Asia gets less than 5%.
High return for high risk
Within emerging markets, Hu told FSA that he finds Mongolia particularly attractive. The country, which has a large mining industry, is profiting from the commodity price recovery as well as an IMF programme that has helped to improve the institutional framework, he said.
Other countries also benefit from a rise in commodity prices, but “Mongolia has the political will to implement the reforms,” Hu said.
In fact, he believes Mongolia is the rising star of the portfolio. He said bonds from Mongolia have a total return in US dollars of 22% year-to-November, well above the fund’s benchmark JP Morgan EMBI Global Diversified Index return of 9.45%.
A new Mongolian government elected last year “appears keen to repair its image among investors. It has already pushed through a comprehensive reform package to reduce the budget deficit in the short run and diversify the economy in the medium term”, Hu wrote in a recent client note.
However, he forecasts two potential risks: the commodity volatility and the still weak political situation in Mongolia. “As a young democracy the political cycle tends to be more volatile. It is an important risk to watch for”.
Hu sees potential as well in Eastern Europe, mostly in Ukraine. The fund had a material overweight position in Ukraine, also in sovereign and quasi-sovereign bonds, which has returned 18% year-to-November, he said.
“[In Ukraine] you still have a return spread and you have reforms. Ukraine is the country with the biggest IMF programme”, he said.
However, Ukraine has fundamental risks and liquidity is a likely concern. The country continues to struggle with endemic corruption and is engaged in an ongoing armed conflict with Russia in the eastern Donbass region.
High yield risks
Hu said the biggest general risk to emerging market bonds is a more aggressive than expected interest rate policy from central banks that “shocks the market”. However, he doesn’t consider this a base case scenario.
Another concern is that trade disputes, such as the NAFTA renegotiations between the US and Mexico or trade issues between the US and China, worsen and negatively impact global trade.
“[The portfolio] still has a bit more risk than the benchmark to reflect our view.,” Hu said. “Two years ago we had more risk because everything was cheap. But now even though things are not as cheap, we are still constructive”.
His duration strategy is relatively long-term. But instead of investing of in 30-year bonds, he prefers 10 year-bonds. He expects to keep that approach unless central banks get more aggressive and interest rates rise quicker than expected. “Then we might move from 10-year to five-year bonds.”
Regarding China, Hu keeps the country slightly underweight because “from a risk perspective we tend to use the budget for China to fund other riskier markets like Mongolia”.
His firm doesn’t actively trade onshore RMB bonds in its portfolios and he maintains a neutral view on them.
The fund versus the sector over three years
