News Analysis: Nest’s recent move into emerging market debt could signal an opportunity for other schemes following the summer sell-offs, but advisers have warned that choosing the right countries and managers is critical.
EMD is the latest asset class to be added to the investment universe of the circa £535m government-backed mastertrust Nest.
Earlier this month the defined contribution scheme started a tender process for an actively managed global EMD fund, adding to the investment building blocks it currently uses.
The scheme’s move comes as emerging market investments have made more negative than positive headlines since China spooked markets this summer, with sell-offs suggesting that many investors were reassessing their views.
The fiscal positions of many emerging market countries are better than in many developed countries; long term it’s a good investment
Mark Fawcett, Nest
Explaining the reasons for its foray into the asset class, Nest’s chief investment officer Mark Fawcett said: “It gives us another way of accessing emerging market economies in addition to emerging market equities, a slightly different risk profile to emerging market equities, and the ability to access higher yield than is available in investment-grade credit in sterling and globally.”
Nest is planning to use a blended approach of hard and local currencies, which will vary in weighting depending on which is more attractive at a given time, said Fawcett.
The scheme is looking for asset classes “that we think can deliver long-term returns, and emerging market debt has those attractions”, he said.
“The fiscal positions of many emerging market countries are better than in many developed countries; long term it’s a good investment.”
Fawcett said it was important to take a view on specific markets rather than always investing across the board, saying: “Emerging market debt is riskier than investing in gilts or US treasuries. That’s why we’ve gone down an active route, because it needs to be managed carefully.”
Get off the benchmark
Karen Shackleton, senior adviser at AllenbridgeEpic Investment Advisers, said EMD was a “good diversifier”.
“Emerging market debt for me sits at the top end of the low-risk bucket, offering some enhanced return in return for some risk,” she said.
Source: JPM EMBI
Shackleton noted that clients who were considering an investment tended to do so as part of a multi-asset allocation to bonds, a holistic multi-asset investment in which a fund manager has a strategic benchmark allocation to bonds, or as an off-benchmark holding.
“EMD represents an opportunity in a rising interest rates environment as the countries that have been implementing [quantitative easing] start to taper that initiative,” she said.
“As that starts to feed through then EMD could be an asset class that investors start to look at again, having withdrawn a bit in recent years. It’s one of a number of opportunities in the fixed income space that could pick up in yield.”
Pete Drewienkiewicz, head of manager research at investment consultancy Redington, emphasised that EMD investment managers should avoid benchmarks.
It probably isn’t quite the right time to look at it as a massive opportunity because it’s likely that developed market rate rises are likely to continue to give emerging market currencies a bit of a shiver
Pete Drewienkiewicz, Redington
“If you are going to dip your toe then I think benchmark managers are not a particularly good route to go down. Our chosen approach would be much more of an unconstrained total return approach,” he said.
“Particularly in local [currency EMD] there’s a huge overconcentration. There are only 16 countries in the benchmark, so you want to have a manager who can take some off-benchmark exposure.
“There are some frontier countries out there that do issue some local currency debt but which aren’t in the index [and] frontier countries that have dollar-denominated debt but that aren’t in the index; those might be interesting as well.”
However Drewienkiewicz said QE tapering will not help emerging market bonds – at least not those issued in local currencies. “It probably isn’t quite the right time to look at it as a massive opportunity because it’s likely that developed market rate rises are likely to continue to give emerging market currencies a bit of a shiver.”
