Emerging markets debt is attracting more pension fund investors as it has proven to be a resilient asset class, bouncing back from crises and providing strong returns when other markets are falling.
"It's been the highest performing fixed-income asset class we have," said Richard Picket, senior investment manager for fixed-income at the $10 billion San Francisco City & County Employees' Retirement System. He said that in the past three years, the fund's investment in emerging markets debt has had an annualized return of 25.3%, "double the return of the next highest fixed-income manager we have."
San Francisco has $250 million invested with Grantham Mayo van Otterloo & Co. LLC, Boston, an emerging markets debt manager for the fund since 1996). It recently invested $75 million in the emerging markets local currency debt strategy of Ashmore Investment Management Ltd., London.
Because of its strong returns, San Francisco's emerging markets debt investment now totals about 3% of the total fund; its target is 1%. Mr. Picket has recommended to trustees that they raise the target to 3% because he doesn't want to have to cut it to rebalance.
New mandates
While San Francisco has one of the most ambitious programs, other pension funds also are moving into the asset class:
* Arbejdsmarkedets Tillaegspension, Copenhagen, the Danish labor market's supplementary pension fund, has just hired Pacific Investment Management Co., Newport Beach, Calif., and Citigroup Asset Management, Stamford, Conn., to manage $100 million each in emerging markets debt.
* Ontario Teachers' Pension Plan Board, Toronto, invested US$25 million in Ashmore's local currency debt strategy in March.
* City of Montreal Public Employees' Retirement Fund; City of Austin (Texas) Police Retirement System; and Houston Police Officers Pension System all invested in Ashmore's emerging markets liquid investment portfolio. That strategy invests in dollar-denominated sovereign debt from emerging markets countries. Montreal invested US$40 million; Austin Police, $10 million; and Houston Police, $60 million.
"Emerging markets debt is a good diversifier. It is not highly correlated to other asset classes and has high expected returns," noted Henrik Getsen, head of fixed-income investing at the 246 billion Danish kroner (US$ 33 billion) ATP fund.
Marie Therese Thomas, pension fund investment officer for the C$2.1 billion (US$1.3 billion) City of Montreal fund, said, "The Canadian bond market performed well because interest rates came down, but we were looking for new ways to get higher returns from the bond market."
A source close to the C$3 billion (US $1.9 billion) Ontario Teachers fund said the move into emerging markets debt is part of its move away from U.S. and developed market equities (Pensions & Investments, June 24) and into alternative asset classes that appear likely to have higher returns.
Although there have been some big debt defaults in emerging markets -most notably that of Argentina in 2001 - believers in the asset class say there are enough good investments around to make up for it.
And some money managers think defaults actually provide opportunities.
Russia was spectacular
"Sometimes the best opportunities follow a period of default," said William Nemerever, partner and co-manager of the fixed-income group at GMO. "For the last couple of years, Russia (which defaulted on its debt in 1998) has been a spectacular performer."
Mr. Nemerever said GMO now has an overweighting in Argentina, even though no restructuring plan has been formulated. He said GMO uses credit default swaps to protect its investments in countries that seem likely to default on their debt.
"If the bond defaults, you give it to the insurer and they give you par for the bond," he said. Mr. Nemerever said GMO had a big position in Argentina, which it had insured, so when the default occurred, "we were not hurt as badly as we might have been."
He pointed out that the Ivory Coast is also in default on its debt, which is up 31.03% year-to-date through June 30. GMO also has a large position in Brazil, which makes up about 10% to 12% of its portfolio, according to Mr. Nemerever, despite the recent problems in that country.
"Brazil is one of the largest components of the universe; you can't ignore it," he said.
Mohamed El-Erian, head of emerging markets debt for PIMCO, said his firm has investments in Brazil, but not Argentina.
"Brazil has sound fundamentals; you have to navigate the bumpy environment," he said. But Mr. El-Erian said Argentina is "out of most people's portfolios. It's a tragic situation that's getting worse. At 20 cents on the dollar, it's still too expensive."
Argentina has had an effect on the benchmark returns on emerging markets debt. The J.P. Morgan Emerging Markets Bond Index-plus and the EMBI global-constrained are the benchmarks used most often for measuring emerging markets debt performance. While the EMBI-plus was up 0.82% year to date as of June 30, it was down 0.75% for all of 2001, because Argentina's bonds were in the index. Starting in 2002, Argentine bonds were removed. The EMBI global-constrained index was up 2.36% year to date as of June 30, and up 9.7% for 2001, with Argentina's bonds removed from the index.
Topping indexes
Some money managers have been able to outperform the indexes. Ashmore's EMLIP fund was up 9.23% year to date as of June 30 and up 22.14% for all of 2001. Ashmore's local currency portfolio has an 11.65% return year to date and had a 12.95% return for 2001. Ashmore, which only manages emerging markets debt, has $1.5 billion under management.
GMO's three-year annualized return is the 25.3%, according to the San Francisco fund; the portfolio returned 5.14% year to date through June and 14.2% for 2001. GMO manages $1.4 billion in emerging markets debt.
PIMCO, which manages $1.3 billion in emerging markets debt, had a 0.4% return year to date as of June 30 and a return of 28.19% for 2001.
Citigroup Asset Management's emerging markets debt portfolios are managed by subsidiary Salomon Brothers Asset Management. Peter Wilby, chief investment officer for fixed income for Citigroup, said its emerging markets debt portfolio returned 0.85% for the year through June 30. Citigroup manages $1.4 billion in emerging markets debt.
