Emerging markets debt has turned into a safe haven for institutional investors as equity markets in the developed world continue their dismal performance.
The J.P. Morgan Emerging Markets Bond index, the benchmark for most of the industry, is up 7.06% year-to-date through March 12. In comparison, the Lehman Aggregate Bond index is up 1.78% year-to-date as of March 12.
On the equity side, the Morgan Stanley Capital International Emerging Markets Free index was down 7.66% year-to-date as of March 12. Its performance has just about matched that of the Standard & Poor's 500 index. However, there are strong pockets of outperformance by a number of individual countries, including China and Russia.
Jane Brauer, a fixed-income strategist at Merrill Lynch & Co. Inc., New York, came out with a report last week that declared, "U.S. dollar-denominated emerging market debt has provided the highest annualized returns compared to all other U.S. dollar asset classes over the last 11 years and in all cumulative periods looking back from today." The report said the returns of emerging market sovereign debt have been a compound annualized 12.77% for the 11 years dating to Feb. 28, 1992.
The performance has not gone unnoticed.
According to data tracked by eMergingPortfolio.com, Boston, $691 million has flowed into institutional emerging market bond funds from Jan. 1 through the week ended March 5, more than the $647 million that flowed into emerging market bond funds for all of last year.
"We're seeing more interest in emerging market debt and emerging market equities," said William Nemerever, partner at Grantham, Mayo, van Otterloo & Co. LLC, Boston, which manages $1.9 billion in emerging market debt. GMO's emerging markets debt fund is up about 7.1% year to date through March 12.
The San Francisco City & County Employees' Retirement System has $287 million invested in emerging market debt with GMO and Ashmore Investment Management, London.
Dick Picket, senior investment officer, fixed income, at the $10.3 billion San Francisco fund, said he actually had to take money away from the emerging market debt investments because they performed so well, they exceeded their allowable range in the fund's portfolio.
"For the next 10 years, emerging market bonds will probably outperform equities," said Mr. Picket. He said the GMO emerging market debt fund has had a 22.2% compound annualized return for the four years the San Francisco fund has invested in it. For the fourth quarter of 2002, when San Francisco made its investment, the Ashmore local currency fund had a return of 5.96%.
Tom Croft, chief investment officer-debt at DuPont Capital Management, Wilmington, Del., which manages the $20.8 billion E.I DuPont de Nemours & Co. Inc. pension fund, said the fund now has $230 million invested in emerging market debt. Last year, he said, "emerging market debt beat everything else to death." However, he added that "you really have to have a conviction about the countries you invest in," because of the potential for crises. "If you're willing to take bets, the market offers opportunity," he added.
Abby McKenna, head of emerging market debt at Morgan Stanley Investment Management, New York, said there is "an increased willingness (of investors) to take risks in fixed-income asset classes."
Ms. McKenna said bonds have performed well in all of the emerging market countries that have oil, including Russia, Mexico, Ecuador and Colombia. "A number of countries have seen windfalls from oil prices," she said. Brazil also has recovered from the crisis in confidence it suffered last year, she added.
Brazil bonds have been up almost 17% year to date through March 12, according to Ms. McKenna. Russian bonds also have performed well and are up 9.9% year to date.
She said there is definitely more interest from pension funds in the area. "With the current dilemma facing pension funds of large funding gaps, plan sponsors are naturally going to consider a broader range of asset classes where the returns have been good and, more importantly, have the potential to be good prospectively, said Ms. McKenna. Morgan Stanley manages $4 billion in emerging markets bonds.
"The most persuasive argument for emerging market debt investments is when you show the total return performance and look at the crises that have occurred in these markets," said Michael Hasenstab, portfolio manager/analyst for international bonds, for Franklin/Templeton Investments, San Mateo, Calif. "They show that it's not a catastrophe to have a crisis in one country," he said. The firm manages $1.2 billion in emerging market debt.
Ashmore received eight RFPs in a single week earlier this year, according to Jerome Booth, director of research.
"The flow of money is not a flash in the pan," said Mr. Booth. "It's growing quarter by quarter."
Ashmore's emerging market debt funds had returns in the 20% range for all of 2002 and are up about 6% year-to-date through March 12.