25.11.2010

How do you manage your fund? Is your strategy more passive oriented “buy & hold approach“ or “day-to-day management”?

Our portfolio turnover is relatively low, but the data supporting the models that generate buy/sell signals, which are subsequently tested fundamentally, are updated continuously. The time how long a security is in our portfolio depends on how quickly or slowly the signs of undervaluation (according to our valuation methodology) disappear. In principle, this can be from one week to one year or even more. But in general, mispricing in bond markets takes longer to correct, so we have very little bonds that have been in the portfolio less than 3 months.

 

What is the duration of your portfolio?

3.6 as of 19.10.2010

 

How are you doing against benchmark?

We’ve lagged during the summer market rally, basically because of 2 reasons – we are restricted to invest only in BB- or better sovereigns and BBB- corporate outside of Eastern Europe. These are the segments that have contributed to benchmark the most (e.g., Venezuela, Argentina). The other reason is duration – our portfolio is deliberately more conservative – our duration is 3.6 versus the index of ~6.2. In the rallying market, the long end outperforms.

What is the actual cash position?

Almost 18% as some paper was sold as it turned overvalued by our methodology, and we were hesitant to buy into the peak. After the light pull-back on the markets just recently, we expect this to go down to 12-14% in a short while.

Can you “introduce” Top 5 position of the fund portfolio?

All of these holdings are sovereign issues. The Malaysian Airlines is guaranteed by the government too. In general all of the issuers can boast better fiscal fundamentals than most of the developed markets.

Do you believe in Emerging Markets decoupling theory?

Partly. Fiscal and macro indicators are indeed by far stronger in EM and support the thesis. But we also see two strong caveats. First, should a double-dip recession scenario evolve (not our base case though), coupled with hiccups with the loose monetary policies, the incremental cash generated through commodity exports by EM countries would decline disproportionately and worsen the picture of EM. In other words, we believe sustainable debt levels in EM are still lower than in DM (yet we also believe many of EM countries are far from hitting these levels). Second, the domestic demand growth momentum in several EM countries is waning, so the growth outperformance will diminish, but will still remain.

Note: EM = Emerging Markets, DM = Developed Markets

Are you a double-dip believer or you bet on a recovery?

We expect very slow recovery, but no double dip. For markets, the monetary policy decisions are key factors, in our view.

How is emerging market debt cheap or expensive relative to other fixed income classes?

In general, we believe EM sovereign debt is relatively expensive, but EM corporate debt is cheap relative to, e.g., DM HG and DM HY, respectively.

Note: HG = High Grade, i.e. Investment Grade, HY = High Yield, i.e. sub-investment grade.

What do you suppose would be the market reaction (especially bond markets), if Greece would defaults next year?

I think it is largely priced in, at least for EM I do not expect strong repercussions. As a case in point, in May when the Greek stress was at its peak, EM debt weathered pretty well – there is little to none direct link from Greece to EM.

A lot people talk about „bond bubble“ these days. What is your take? What is you actual view on bonds? (state, corporate, high yield)

Depends on what you compare with. On the face of it, when looking at individual instruments, I sometimes just can’t believe how low the yield can be. But then I look at spread measures and it’s not so catastrophic. Also compared to similar deposit rates, EM bonds still seem a better deal. We are in the “new normal”. Apparently, there are not that many great positive NPV ideas in the real economy if the people keep bringing money to banks (or buy bonds) even at these “ridiculous” rates. To conclude, I believe/hope, this will reverse, but really don’t expect it to happen in the next half-year or so.

Note: NPV = Net Present Value

All markets are operating in tandem (high correlation) now and finding ways to really hedge are really hard to find. What is your hedging strategy?

Basically we do not do any hedging apart from certain FX risks if we have any in the portfolio. We see it that we have a mandate for the EM debt market, so we are supposed to take that risk at all times. I admit, though, that to some extent we use cash as a hedging instrument (if that qualifies).

What is your view on expansionary monetary policy especially on quantitative easing (QE)?

Very unfortunately it had to be resorted to. In very general terms I think it’s counter-productive, but then again nobody knows what the world would look like without it. But now that we have it, it will remain around for a while. However, I don’t expect (and truly hope) that Japan scenario will repeat on a global scale. I expect QE will start to be rolled back 1.5-2 years from now, with the markets re-pricing ~1/2 year before that. Of course sudden spike in bank lending and ensuing inflation can bring this forward, but there are no immediate signs of it happening at least yet.

What you think about shortened time horizons of most investors these days?

Don’t have any strong opinions or facts. I don’t know if this is related to the question, but I find it worrying that many banks are OK to buy financial instruments, but are not that ready to issue equivalent loans. The underlying assumption that markets are liquid but loans are not works only in the “good times”. If there is a “black swan” event ahead and the liquidity disappears, we may end up in a deep trouble. And it is relevant for any market from money market to HY bonds to EM bonds to equities.

What is your economic outlook for emerging markets /2012/?

We expect the EM economies to surpass DM in growth for several years to come, even if the Chinese RE market corrects (I don’t call it a bubble, but it is hot and slowdown is needed) on such strong fundamental factors as demographics, level of GDP and strong institutional frameworks in place. I truly believe in the gradual shift of economic and financial centers eastwards.

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