PORTFOLIO SPOTLIGHT
rencies used in international commerce. Most of the assets by far are held in sovereign debt, with a roughly 50 / 50 split between local and hard currencies.
The fund doesn’ t hedge its local currency exposure because Fine says doing so means“ you’ re basically paying away all of your local carry.”
His team comprises deputy portfolio manager David Austerweil, chief economist Natalia Gurushina and senior corporate analyst Robert Schmieder. They work closely with VanEck’ s broader emerging markets fixed-income and equity platform.
The fund’ s management team is indexagnostic and employs a bottom-up approach to securities selection. The first, strictly quantitative step is to generate a list of securities that are cheap in the EM bond universe. Step two applies qualitative judgment to eliminate bonds that might be cheap on a quantitative basis but not when adjusted for risk.
In a case of the latter example, the VanEck fund excluded Russia in the runup to the country’ s February 2022 invasion of Ukraine. Fine notes that Russian bonds looked cheap at the time, but a closer look made it doubtful that any spread on its bonds over U. S. Treasurys could compensate for the economic damage caused by international sanctions.
ETF Conversion
The VanEck fund has been a top-quartile performer in Morningstar’ s U. S. emerging markets bond category over the last five and 10 years, with a top-half ranking during the three-year and one-year periods as of June 9.
According to Morningstar, the fund has sported a higher standard deviation measure than the category and index during the past 10 years. But Fine contends that this is a poor comparison, arguing that Morningstar hasn’ t properly characterized his fund’ s blended portfolio.
“ The past several years of geopolitical risk, higher commodity prices and greater understanding of the fiscal challenges facing developed markets has resulted in a natural increase in interest in
EM bonds,” Fine says.
“ Morningstar has mostly dollar-dominated EM bonds, not blended bond funds,” he offers.“ And dollar bonds in general have done better than local-denominated bonds, and yet we’ re still in the top 10 % [ in the fund’ s category ] over the past 10 years on Morningstar.”
The fund, which launched in 2012, converted from an open-end mutual fund into an exchange-traded fund last October.
Rethinking The‘ 40’ In 60 / 40
Fine preaches the virtues of bond portfolio diversification, but until fairly recently the message seemed to fall on deaf ears. As a result, he feels fixed-income portfolios remain too heavily skewed toward developed-market bonds and that this overrepresentation has soured people on fixed income in general.
“ I think a big part of the problem is that most investors think of the 60 / 40 model and see that the 40 hasn’ t done well, and as a result they want less 40,” Fine says.“ The problem is they have the wrong 40 with their heavy tilt to over-indebted developed market bonds.”
He explains that institutional investors and pension funds have been the primary market for EM bonds, but even those allocations are on the low side at roughly 3 % to 5 %. Meanwhile, U. S. retail investor exposure to EM bonds barely registers a blip on the radar. But he sees that changing.
“ The past several years of geopolitical risk, higher commodity prices and greater understanding of the fiscal challenges facing developed markets has resulted in a natural increase in interest in EM bonds,” Fine says.
He has a loose take on the ideal allocation to EM bonds.“ Not zero [ allocation ],” he says.“ That’ s my only recommendation. Asset allocation after that is art, it’ s not science.”
Outlook
Fine believes that emerging market bonds will continue proving themselves in coming years.
“ I think the next four to five years will see the ongoing strength of EM, and countries with good fiscal policies and independent central banks will increasingly be acknowledged and rewarded,” he offers.
“ I think commodity prices are high because of supply risks, and I don’ t see that changing. And this is a supportive factor for EM bonds,” he adds
But what could go wrong with his thesis? Declining commodity prices, for starters. Or perhaps smarter, more disciplined policy decisions by governments in developed markets.
“ I kind of joke that one thing that could go wrong is that the U. S., U. K. and Japan get their act together and adjust all fiscal policy and have an independent central bank that will base rates entirely on their inflation views,” he says.
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