Peter Eerdmans, the manager of the Investec Emerging Markets Debt fund, says his focus on local currency debt means he is able to generate returns from two sources: bonds and currencies.
The £154m specialist fund was one of the first of its kind when it was launched in June 2006.
“A lot of people are investing in dollar bonds issued by emerging markets, which rely on yield compression for capital gains,” says Eerdmans.
“Investing in local currency debt means you get yield compression and currency returns. In the long-term, it is a double source of returns,” he says.
Eerdmans says the emerging market debt sector is “still in a sweet spot”. Bonds are well supported by monetary policy, with central banks keeping interest rates low, and low inflation, he says.
“At the same time, risk appetite is returning, especially for emerging markets, so we are seeing investment inflows, and economic growth in emerging markets means currencies are well supported by trade flows,” he adds.
Eerdmans says he has moved to take longer positions on the bond side as yield curves have steepened.
He is also taking advantage of the attractive valuations of inflation-linked bonds. “Nominal bonds have rallied sharply but market pricing of inflation is very low,” he says. “For example, in Turkey, the market is pricing inflation at 3.5% against expectations of 5% to 6%, in Chile it is as low as 2% and in Poland 1.5%.
“So we have moved a greater portion of the portfolio from nominal into inflation-linked bonds,” he says.
On the currency side, Eerdmans says he has increased his exposure but describes his holdings as “a pretty neutral basket.” He says he now has more outright long positions compared with the first half of the year, where he held a more even balance of long and short positions.
Eerdmans says he likes currencies that have been laggards, falling behind their peer groups. He gives two examples: the Mexican peso and the Philippine peso.
“The Mexican peso was lagging behind Brazil and Columbia, but is now benefiting from the American recovery,” he says. “The Philippine peso is still cheap, compared to the Indonesian rupiah, as expectations of migrant workers returning home due to the recession have been unfounded.”
“Whilst the [South African] rand has had a good year, it is now a bit overdone,” he says, “but the rouble is still attractively valued. It has fallen behind the price of oil, with which it is traditionally closely correlated, which makes it attractive.”
Eerdmans expects 2010 to be a good year. “A new economic output cycle has started, there is lots of room to close the output gap, and inflation will not be a major problem,” he says.
“Markets will be volatile, but this will create opportunities to buy in corrections. Emerging market currencies should continue to do well,” he adds.