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Looking Beyond the Confines of Emerging-Marketing Indexes

An Institutional Investor Sponsored Report

Are there issues with the emerging-market indexes?
While we believe indexes may be useful as the beta foundation for more traditional fixed-income strategies, we do not believe they are well suited for that role in emerging markets because the two main emerging-market debt indexes* can unnecessarily exposure investors to unintended and unwanted risks. 

What are the risks associated with the indexes? 
One risk is higher volatility than is necessary due to index concentration.  For example, the local sovereign benchmark is comprised of 16 countries. Within that benchmark, the top eight countries by weight represent approximately 77% of the benchmark** which means that half of the index is only 23% of the benchmark.  Moreover, the composition of the benchmark is based largely on the issuer’s market capitalization, which typically increases because a country is issuing more debt than others – something that might be a sign of fiscal weakness. Finally, we believe there is a potential opportunity cost in managing a portfolio too close to the GMI – EM benchmark. As I mentioned earlier, the index is comprised of only 16 countries.  At Eaton Vance, we are actively considering local market opportunities from a set of approximately 90 countries which is a blend of emerging and frontier markets.

What other risks should investors be aware of?
Significant exposure to developed market risks such as U.S. interest rates and the euro/dollar exchange rate which may be unwanted. The EMBIG entails credit spread and interest rate risk of the reference currency, which in this case is the U.S. yield curve.  By way of example, as of December 31, 2014, the EMBIG had a U.S. duration of 6.9 years – higher than the 5.5 years of the Barclays U.S. Aggregate Index and just slightly less than the 7.2 years of the Barclays U.S. Corporate Bond Index.

How does the Eaton Vance Institutional Emerging Market Debt Strategy address the shortcomings of the indexes?
By considering a broad opportunity set of approximately 90 countries, our strategy seeks to provide significant non-benchmark emerging market exposure for greater diversification, duration and currency flexibility, and lower volatility than benchmarked strategies.  We are looking to generate alpha through a complete market cycle, significant tracking error and a high information ratio relative to our peers by utilizing a wide range of cash and derivative instruments to express our views on country-level currency, credit spreads and interest rates.

Do significant off-benchmark exposures raise any specific risks that investors need to be made aware of?
Our view is that investment management is risk management. It is an all-consuming topic for the investment team, not just the risk management teams that operate firm wide. Now, in EMD there are large, well-known risks, like liquidity. We think one should always be concerned about liquidity, but I don’t think the issues are any more acute in EMD vis-à-vis other markets. But we believe micro risks are even more critical, because they are so often overlooked. These would be the risks associated with idea implementation. How do you structure and settle your trades? How do you enter a market? How do you exit the market? For example, in Nigeria, where we have been investing for years, investors need a currency importation certificate when bringing money into the country. Without one, it can be difficult to get your money out. These are unglamorous, but vital, aspects of risk management, and investors need robust infrastructure and the right skill set to identify risks at every step of the investment process, make sure they are being compensated for those risks, and minimize those risks where compensation is lacking.

This material is presented for informational and illustrative purposes only and should not be construed as investment advice, a recommendation to purchase or sell specific securities, or to adopt any particular investment strategy. This material has been prepared on the basis of publicly available information, internally developed data and other third party sources believed to be reliable, however, no assurances are provided and Eaton Vance has not sought to independently verify information taken from public and third party sources. Information contained in this material is current as of the date indicated and is subject to change at any time without notice. Future results may differ significantly from those stated, depending on factors such as changes in securities or financial markets or general economic conditions.  The views and strategies described may not be suitable for all investors.
Investing entails risks and there can be no assurance that Eaton Vance, or its affiliates, will achieve profits or avoid incurring losses. It is not possible to directly invest in an index. Past performance does not predict future results.

* The JP Morgan Emerging Market Bond Index – Global Diversified (EMBIG) and the JP Morgan Government Bond Index – Emerging Markets Global Diversified (GBI – EM)
** as of December 31, 2014. Source: Eaton Vance, JP Morgan

Contact Information:
Eaton Vance Management
Two International Place
Boston, MA 02110
Matt Witkos, President, 
Eaton Vance Distribution

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