Is Emerging Market Debt This Year’s Junk Bond?

From aiCIO Magazine's April Issue: When you're investing outside the mainstream, it's not just what you're doing that counts, it is what everyone else is doing too.

To see this article in digital magazine format, click here.

The year 2012 will probably be remembered for many things—the London Olympics and the US presidential election for starters— but for investors, it may be the year of emerging market debt. Thus, it might just be a year to forget.

After the quasi-meltdown of the Eurozone and a United States economy that has failed to fire back into life, investors have been looking around for uncorrelated, positive-yielding assets to help them meet their liabilities and diversify their risk budget. Emerging markets are on the top of the pile for many, but not in the way they were before the financial meltdown. Back in the mid-2000s, investors piled into these developing stock markets, but many pulled out at the first sign of trouble in the wider world. Others didn’t move quickly enough and found “liquidity risk” was not just something they read about in the small print at the end of a consultant’s presentation.

This time the story is different: debt, issued in local currency, is the asset class du jour. Because of the heightened risk associated with the asset class, yields are higher than even low-grade developed market corporate debt. According to Thomson Reuters, some $314 billion in emerging market corporate debt was issued last year, and by the end of March this year, some $113 billion had been issued, making it a record quarter. These companies are moving away from issuing in dollars as their own currencies are getting stronger, or else they do not feel the need to attach to the US in order to earn acceptance from investors.

For more stories like this, sign up for the CIO Alert newsletter. 

So there’s no shortage of supply and, it appears, no shortage of demand, as large investors across the developed world are tendering for managers offering a way into asset class. But caveat emptor: there’s a reason for the high yield, even if some think this debt might be a touch overpriced. “Investors are either looking at emerging market debt as a strategic investment or a tactical opportunity. Arguably, if they are considering the latter, it’s too late,” says Crispin Lace, Director in Consulting & Advisory Services at Russell Investments. “The potential downside is that there is political risk and correlation with other assets, but additionally emerging market debt is susceptible to panic. At the first sign of bad news, emerging market debt is going to be marked down even if there is no direct link, whereas debt issued by the United Kingdom or the US isn’t.” This is what happens to perceived “risky assets,” of course. No one remembers the financial crisis in South East Asia in 2008, because there wasn’t one, but its markets tanked as investors were spooked by what was happening in developed markets.

Despite emerging markets being less indebted than their overexposed developed neighbours, they are still going to be hit should the world come to an end (almost) again—and like high-yielding assets before them, risk isn’t always where you think it might be hiding.

—Elizabeth Pfeuti

From aiCIO Magazine's April Issue: The line between the two camps are blurring; can both 'outsourced' models survive and will the client even end up the victor?

To see this article in digital magazine format, click here.

Turf wars are never pretty, especially when there is money involved, and the current war unfolding in institutional asset management is getting nastier by the day.

A campaign by investment consultants to drive more revenue in the tough times of the financial crisis, when investors were afraid to move from their agreed portfolios, started with slight disgruntlement, but has turned into something altogether more bloody. Let’s set the scene: Almost 18 months ago I published an article about consultants starting to take on asset managers at their own game, and running the client money they used to place with third-party companies themselves. Mercer had just announced it had appointed a fund management veteran to lead its sales team, and its competitors were also ramping up their delegated consulting/fiduciary options.

I was contacted by unhappy fund managers who were annoyed at the latest development, but were sure they could stave off the competition. At the same time, consultants told me they didn’t want to be asset managers or sell this new business model—nor did they want to be paid less than the fund managers for doing the same job. The argument rumbled on with significant bed-hopping as consultants moved to asset managers, asset management staff took their places at consultancy firms, and some even went to work for the investors in-house.

For more stories like this, sign up for the CIO Alert newsletter. 

Fast forward to March this year and the annual investment conference of the National Association of Pension Funds in Edinburgh, Scotland. “You remember that story you wrote? About consultants becoming fund managers? It’s getting worse and we’re not having it,” snarled the Head of European Sales of an asset manager over a beer. “We’re cutting them out,” he said, with no hint of humour. “We don’t even want them in the room when we are pitching. These are our ideas and they are now our competitors. We’re going direct.”

And they are. Asset managers large and small are ramping up their fiduciary management teams to meet consultants on the battlefield. Why would you need a consultant if the asset manager were able to advise you on asset allocation, risk management, and liability matching? You wouldn’t. Or so the asset managers would like you to think.

The consultants, for their part, are moving further toward “asset management status” and a lack of U-turning (at least visibly) would suggest they are gaining ground. Increasing anger amongst fund managers suggests this is also the case.

Fund managers are stuck, though. However much they are irked by what their once-partners are doing, they still have to work with them. How else will they get on a buy list, which is still of utmost importance? And for all their posturing, consultants do not have the in-house capability to run all asset classes for their investor clients, so a certain amount of outsourcing has to continue.

“I have watched tennis for years,” said one asset management sales head, “but I wouldn’t say I could take on Roger Federer, and that’s what they are doing.”

What it all comes down to, of course, is the client. What do they think of what is going on? “The consulting model is broken,” said one of the pension fund managers in the “Forty Under Forty” section of this issue. “They have their monthly revenue targets to hit and that doesn’t always mean the best outcome for the client.” Forums in which asset managers can meet their clients to talk about performance, objectives, and corporate governance directly are increasingly cropping up across the buy-side—and no consultants are allowed.

It is not all one-way traffic, of course. A growing number of pension funds are bringing their investments in-house to cut out the asset managers—and it is not just the big guys doing it. Pressure on fees has forced some to reduce investor costs, and clients realize they can do more than just manage government bonds in-house without the help of asset managers. And now there is no shortage of staff to help them do it. The lesson: Consultants and asset managers should be careful that while they are squabbling over the spoils of the battle, they don’t both end up falling on their own swords.

—Elizabeth Pfeuti