In Emerging Markets, Active Fixed Income Investors Look for ‘Speedboats, Not Oil Tankers’
Amid volatility, pricing errors, and uneven information, fixed income investors call for active strategies in emerging markets. They seek active asset managers with sound investment hypotheses and the flexibility to tailor strategies to institution-specific needs, according to new research from Vontobel and II’s Custom Research Lab.
As the global pandemic wanes – one hopes – and the world’s economy wrestles with high inflation and geopolitical conflict, institutional investors say they’re increasingly likely to look to EM fixed income for diversification, yield, ESG alignment, and other benefits. Investors are eager to increase these allocations in the years ahead, most often by investing in corporate bonds and, to a lesser extent, sovereign debt. Survey data indicates that on the one hand, investors are optimistic about the economic prospects of emerging markets, and on the other hand, they are clear-eyed about the asset-specific and market risks of investing in EM fixed income. With this in mind, nearly 80% of investors in this study endorse active strategies over passive/index strategies, as shown below. Investors are most likely to select broadly diversified active strategies as their preferred method for EM fixed income investment over the next two years, which seems in line with their abiding concern for the diversification offered by EM fixed income. More than one-third of respondents see more focused, high-conviction strategies as their method of choice for investing in EM fixed income.
“We are 100% active,” says the head of a Swiss pension, “because we think emerging markets are not really efficient, and we see that local specialists can really add value with their knowledge. We see emerging market countries that are completely dominated by the energy industry, along with others that don’t have any energy, and so why go passive when we see opportunities to do better with an active approach?” He endorses a high-conviction strategy composed of 30-40 positions, but since his allocation is shared across several managers, each with many positions, it is in effect broadly diversified.
He looks for managers that have the freedom to take advantage of opportunities and points out that “we trust more in the manager himself – the person – rather than the name of the firm.” Such managers, he says, are typically “speedboats, not oil tankers. If the manager’s volumes are too big, then the opportunities are gone. If you have a small boutique manager, it’s likely to have greater ability to take advantage of market inefficiency, and because it’s small, it doesn’t have to buy every big bond issue just to get the volume.”
Active strategies are the approach of choice for a fixed income analyst at the UK insurer, “but not really because active managers have especially amazing skills in this area. Rather, I think the level of customization and tailoring that we want in our mandates can’t be achieved with passive funds. In terms of having a short duration, with specific credit rating limits, along with ESG considerations and exclusion of particular countries – suddenly we have a mess of additional constraints that can’t be addressed with a passive strategy. Firm-wide, we generally use active managers in segregated mandates, because you can customize everything for our needs, which is a big requirement for us.”
This article is adapted from the research report, Institutions Look to Emerging Market Fixed Income for Yield, Diversification, and ESG Alignment, published by Vontobel Asset Management and II’s Custom Research Lab in May 2022. The study includes survey data from more than 300 asset-owning institutions worldwide and interviews with ten investment decision makers at such institutions. Click here to download the full report www.vontobel.com/fi2022.