Short duration EMD combines higher yields with protection against rising rates

21/06/2018

Emerging Markets Debt (EMD) continues to offer strong yield spreads to developed markets, while investing in shorter duration bonds guards against rising interest rates, suppresses volatility and presents beneficial reinvestment opportunities. As such, short duration EMD hard currency (HC) offers an option for investors seeking strong risk adjusted returns in their fixed income portfolios.

MD offers investors an attractive premium versus developed market bonds; the EMD HC yield spread is 472 basis points to German 10-year bonds and 225 basis points to US Treasuries. Despite some recent volatility, emerging market fundamentals remain sound. External balances of many EMs have improved in recent years, current account deficits have been dramatically reduced and debt levels have declined. Regardless of some acceleration due to a pick-up in economic growth, inflation in emerging markets is fairly low. Real interest rates are still relatively high, providing higher risk premiums for investors as well as a buffer for local central banks against the need to hike interest rates. 

Within the EMD HC universe, short duration presents further benefits, particularly in a rising interest rate environment. The first of these benefits is to reduce volatility. Movements in total return tend to be more subdued for shorter duration bonds than for the longer duration bonds issued by the same borrowers. For example, over the summer period of 2013, in May and June the EMBI Global Diversified index lost 8.87% while the 1-3 year sub-index only lost 1.41%. While the direction of the return is usually the same, the amplitude of the index-level fluctuations is less for the shorter-duration sub-indices. This lower volatility contributes to stronger risk-adjusted returns.

A second benefit of EM short duration bonds is the reinvestment opportunities that such a strategy affords. NN Investment Partners’ short duration product targets a duration of 1-3 years. In such a product, principal payments occur sooner, which, in an environment of rising US interest rates, facilitates reinvestment at higher rates.

Finally, short duration bonds offer greater credit roll-down returns compared to longer-dated bonds. As a bond approaches maturity, the probability of default or another credit event in the remaining outstanding period of the bond decreases, presenting a positively sloped credit curve. It is this positive slope that allows for roll-down return. However, this relationship is usually non-linear, with a steeper curve at short durations, as shown below in Brazil’s sovereign yield curve. A focus on shorter dated EM HC bonds therefore helps the strategy profit from strong roll-down returns that can be earned on this part of the yield curve.

Brazilian sovereign spread vs maturity

Source: Bloomberg, NN Investment Partners

Annemieke Coldeweijer, Senior Portfolio Manager, Emerging Markets Debt at NN Investment Partners: “We have a constructive view on emerging market hard currency bonds, based on a relatively benign global macroeconomic backdrop and economic indicators pointing to robust global growth dynamics. As the strengthening of economic conditions increases the risks of monetary tightening, short duration EMD provides an ideal way to mitigate the impact of potential rate rises, while providing an attractive premium and lower volatility.”

NN Investment Partners launched its NN (L) Emerging Markets Debt Short Duration (Hard Currency) fund in March 2018.The fund targets a duration of 1 to 3 years, enabling the fund to offer stable income and lower volatility.

NN (L) Emerging Markets Debt Short Duration (Hard Currency) is a sub-fund of NN (L) (SICAV) , established in Luxembourg. NN (L) (SICAV)]* is duly authorised by the Commission de Surveillance du Secteur Financier (CSSF) in Luxembourg. Selected share classes of the sub-fund are currently registered in Luxembourg, Italy, Austria, Sweden, Finland, Denmark, Norway, Portugal, Spain, United Kingdom, Germany, The Netherlands.

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About the author

Annemieke Coldeweijer

Annemieke Coldeweijer

Portfolio Manager

Experience since 2003

Business Experience

2017 - to date Annemieke is a Portfolio Manager EM Corporate Debt within the EMD Boutique of NN Investment Partners. She has dual portfolio management and credit analysis responsibilities. She covers Oil & Gas, Metals & Mining, Media, Chemicals, Transportation, Industrials, Utilities.

2016 - 2017 Head of the Asset Backed Securities & Covered Bonds team within the Global Credit Boutique of NN Investment Partners and Lead Portfolio Manager for the Asset Backed Securities Portfolios and Senior Portfolio Managers for the Covered Bond Portfolios.

2014 - 2016 Head of Securitised Investments at NN IP, responsible for a specialist team of 3 investment professionals managing securitised investments, primarily in the European markets. These involve both in-house and third party clients.

2007- 2014 Senior Portfolio Manager Securitised Investments team at NN IP

2006-2007 Portfolio Manager for the NN ING Insurance Clients, responsible for the general portfolio management of the In-House Insurance Portfolios

2003-2006 Quantitative Analyst at AEGON Asset Management, responsible for Portfolio Construction and first line Risk Management on corporate bonds

Qualifications

VBA (Dutch equivalent of CFA)

MSc in Econometrics from Tilburg University in 2003

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