IA Clarington Emerging Markets Bond Fund
Manager commentary - Q3 2019
An abrupt escalation in the U.S.-China trade dispute led to a decline in global bond yields as markets re-assessed the impact of the dispute on the global economy. The trade dispute remained a key driver of risk sentiment and drove underperformance in May and August, and outperformance in June, July and September. Central banks were another driver of risk and return, as expectations of monetary policy easing to meet sluggish global growth was a major contributor to equity rebounds throughout the period, notably in June and July.
The decline of emerging markets debt in August was exacerbated by the surprise victory of Alberto Fernandez, the Peronist opposition candidate, in Argentina’s presidential election, which caused the peso to fall and increased concern regarding Argentina’s ability to continue to service its external debt burden. The decline in U.S. interest rates benefited external debt markets, which delivered consistently positive returns. Local currency debt also fared well, despite the appreciation of the U.S. dollar, as local bond yields benefited from the global trend of declining interest rates, as well as a decline of inflation across most emerging markets economies. This allowed for emerging markets central banks to join the policy easing trend.
An underweight exposure to Argentina external debt, both sovereign and corporate, contributed to performance as U.S. dollar bond prices plummeted following Alberto Fernandez’ landslide victory in August’s presidential primary. Selections among high-yield external sovereign issuers, particularly an underweight position in Venezuela and overweight positions in Costa Rica, Guatemala, Belarus and Kenya also contributed to performance. Underweight allocations to eastern European local debt, of Hungary and Poland, in favour of Egyptian local debt, was another contributor to performance.
Individual contributors to the Fund’s performance included a local Argentina floating rate bond, Argentina (21/06/2020), which benefited from rising local bond yields. A holding in a U.S. dollar-denominated bond issued by Jamaica (8.0%, 15/03/2039) benefited from positive economic trends and public sector reform. An AA-rated bond position in Qatar (5.103%, 23/04/2048) was another contributor as it outperformed.
The Fund’s underweight exposure to local currency debt in June detracted from performance as emerging markets local bond yields and currencies outperformed. A slightly overweight allocation to Argentina local debt detracted from performance following the Argentina presidential primary. The Fund’s U.S.-dollar cash position detracted from performance as emerging markets debt markets delivered strong total returns.
Individual detractors from performance included a bond issued by South African mine operator Petra Diamond Ltd. (7.25%, 01/05/2022), which underperformed as a decline in precious stone prices prompted a write-down of its mine value and a decline in earnings.
The fund manager introduced new positions in high-yield sovereign issuers for which valuations are dislocated from fundamental credit trends following the August sell-off. These included Ecuador, Ghana and Sri Lanka. The Fund’s exposure to external sovereign debt was increased in August, with a focus on high-yield issuers that offer attractive value following the Argentina sell-off. Exposure to local currency debt was increased in June given expectations that the Fed’s interest-rate cuts could provide stability and potential appreciation of emerging market currencies. In addition, declining emerging markets inflation should allow for emerging markets central banks to ease monetary policy, making local bond yields attractive. The fund manager also increased exposure to high-yield external sovereign bonds that feature positive credit trends (Egypt and Dominican Republic), as well as select high-yielding local markets with declining inflation expectations (Brazil and Egypt).
Low-yielding sovereign bonds issued by Saudi Arabia, Peru and Lithuania were eliminated from the Fund, as was a position in local currency Romanian bonds. Exposure to corporate debt was reduced to take advantage of relative value opportunities elsewhere.
Emerging markets debt has recently benefited from an easing of global monetary policy and the deceleration of growth and inflation. The U.S.-China trade dispute should continue to have an impact on sentiment, and the fund manager does not expect that it will be resolved soon. As such, trade-related volatility remains a potential source of volatility, but its negative effects should be offset by easing monetary policy by central banks across the globe.
Emerging markets remain sensitive to capital outflows, but better fundamentals, such as smaller current account deficits, more manageable near-term debt maturities and favourable economic outlooks, make most emerging markets less vulnerable to outflows. The evidence of this is the relatively muted effect of Argentina on the broader emerging markets debt universe. Emerging markets appear poised to benefit from an increase in growth rates relative to developed markets.
While external risk factors and a slowdown in global growth could provide bouts of volatility and challenge investor confidence, the decline in interest rates could also underpin support for emerging markets as investors embark on a global search for yield. Ultimately, the longer-term fundamental backdrop for emerging markets remains positive and the fund manager expects that attractive relative value considerations should lead to robust demand for emerging markets debt.
|Fund and benchmark performance, as at September 30, 2019||1 year||Since inception (Oct. 2017)|
|IA Clarington Emerging Markets Bond Fund – Series A||7.4%||0.2%|
|33.3% J.P. Morgan CEMBI Broad Diversified Index, 33.3% J.P. Morgan GBI-EM Global Diversified Index, 33.3% J.P. Morgan EMBI Global Diversified Index||10.8%||3.6%|
Learn more about IA Clarington Emerging Markets Bond Fund
The performance data comparison presented is intended to illustrate the Fund’s historical performance as compared with historical performance of widely quoted market indices. There are various important differences that may exist between the Fund and the stated indices that may affect the performance of each. The benchmark is a blend of J.P. Morgan CEMBI Broad Diversified Index (33.3%), J.P. Morgan GBI-EM Global Diversified Index (33.3%) and J.P. Morgan EMBI Global Diversified Index (33.3%). The blended benchmark presented is intended to provide a more realistic representation of the general asset classes in which the Fund invests. The J.P. Morgan CEMBI Broad Diversified Index is composed of U.S. dollar-denominated, emerging market corporate bonds. The J.P. Morgan GBI-EM Global Diversified Index is composed of local currency bonds issued by emerging market governments. The J.P. Morgan EMBI Global Diversified Index is composed of hard currency bonds issued by emerging market governments. The Fund’s market capitalization, geographic, sector and credit quality exposure may differ from that of the benchmark. The Fund’s currency risk exposure may be different than that of the benchmark. The Fund may hold cash while the benchmark does not. Overall, the Fund's bond and equity exposure can differ, because the Fund does not use a fixed ratio similar to the benchmark. It is not possible to invest directly in market indices. The performance comparison is for illustrative purposes only and does not imply future performance.