RPT-EM top of the class despite Ukraine turmoil

Fri Mar 7, 2014 10:47am EST

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* Asset class outperforms

* Cheap valuations attract investors

* Funds switch out of Russia

By Sudip Roy

LONDON, March 7 (IFR) - Emerging markets hard currency debt was the best performing fixed-income asset class in February in spite of growing political tensions in several countries, most notably Ukraine and Russia.

While the headlines in recent weeks have been anything but positive, investors are buying the asset class, spurred by relatively cheap valuations. Institutional investors, in particular, are back bidding for assets, in contrast to retail investors that continue to exit emerging markets bond funds.

The latest data from EPFR Global shows that retail accounts have withdrawn USD3.44bn from hard currency emerging markets bond funds this year, and more than USD7bn from local currency accounts.

"Yet despite the outflows, performance in EM FX, credit and local bonds has been anything but weak over the past two to three weeks, despite the developing crisis in Ukraine," said Demetrios Efstathiou, head of CEEMEA strategy at Standard Bank.

"Outflows ought to have caused further weakness and a continuation of the bear market, but they haven't. I think that this is because EM FX, rates and credit have become cheap enough to attract interest from non-dedicated EM investors," he added.

In February the JP Morgan EMBI Global index - which measures the performance of dollar-denominated emerging markets sovereigns - tightened by almost 60bp from a spread of 397bp to 340bp. On Friday it was trading at 336bp.

On a total return basis, the index generated a return of 3.22% last month. Meanwhile, JP Morgan's CEMBI Broad Diversified index, which measures the performance of hard currency corporate bonds, produced a return of 1.70%.

"Despite all [the problems in Ukraine], emerging market hard currency debt was the best performing fixed income asset class during the month of February," said Chris Iggo, CIO, fixed income, at Axa Investment Managers.

Some observers say the performance needs to be put in context with that in January, a month in which the EMBI Global widened by more than 70bp as investors panicked on worries about rising rates, political scandal in Turkey and sinking currencies. "January was a swine of a month," said one emerging markets banker.

EM RECOVERY

But even the escalation of geopolitical tension between Russia and Ukraine and the possibility of a war in the Crimea have failed to dent the emerging markets recovery. While Ukrainian and Russian assets are underperforming - Ukraine's June 2014 bonds have tumbled eight points this year and Russia's benchmark 2030 notes are down three points - other credits are faring much better.

Turkey's CDS spread, for example, has tightened by 40bp over the past month, while Hungary's is also tighter by 39bp. Their performance suggests the market views the situation in the Crimea to be largely contained and these credits are benefiting from investors switching out of Ukraine and especially Russia.

"We have long advocated that the market was wrongly hiding in Russia credit after the current account scare from last year [when US Fed tapering fears led investors to flee certain markets] and we keep that negative bias at sovereign and quasi-sovereign levels," said investment firm Finisterre Capital in a research note this week.

The firm's fund managers also suggested simplistic categorisation of countries, such as the so-called Fragile Five - Brazil, India, Indonesia, South Africa and Turkey - obscured understanding of performance.

"Indonesia is now widely accepted to be out of the Fragile Five vortex, along with India; even Brazil has showed a glimmer of hope with improving macro-economic figures and stronger message from policy makers," wrote the firm's fund managers. (Reporting by Sudip Roy; Editing by Julian Baker)

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