Normalisation of rates is leading fixed income into a great transition from beta players to alpha generation, according to BlackRock’s Sergio Trigo Paz.
Citywire + rated Trigo Paz said EMD hasn’t been immune to monetary policy fundamentals and highlighted where investors should be focusing.
'You have to manage your duration dynamically because if rates are going higher, then you need to be on top of the duration in your fund,' he said at an event in London.
Trigo Paz currently has 0.55 effective duration years in the $2.3 billion BSF Emerging Markets Flexi Dynamic Bond fund and said the majority of EMD funds hold a duration of around seven.
‘If you hedge your duration you get no carry and if you get a shift in rates then you will lose your carry. With EMs you have a hope of achieving positive total return and eventually grabbing some coupon.
‘Whereas in developed markets we pretty much have no hope going forward. This is driving people towards EM and high yield investments in a massive way.’
Be wary of ETFs
Trigo Paz said idiosyncratic risks are important and highlighted how events at the beginning of the year in Turkey, Brazil (5.97% of his exposure) and Mexico (6.49%) caused a rush to buy EMs in general.
‘As the money began to flow into EM ETFs we got $7 billion inflows into our active funds, but the ETFs got almost twice as much. This means that whenever you were differentiating the credits, these guys were actually buying everything.
'In the next 12 months we see a transition from beta to alpha, which doesn’t mean that beta is going to be negative, but as a percentage of your return it’s going to be less important than the alpha that you can achieve.
'Whereas in the last nine months beta was most of your return, with the alpha being marginal,' he added.
ETFs on the agenda
Trigo Paz said investors need to keep a lookout for the amount of money that is being plugged into ETFs due to the amount of beta going into the assets.
‘We have a very close eye on the money that is going into ETFs because ultimately this is where you are buying the beta.
‘This means that you need to start appreciating because idiosyncratic stories could start to become contagious as people focus on what they really have in their portfolios and realise that the tide is moving out.'
Over the three years to the end of September 2017, the BSF Emerging Markets Flexible Dynamic Bond fund returned 15.92% in US dollar terms.
This compares with a 20.81% rise by its Citywire-assigned benchmark, the JP Morgan EMBI Global Diversified TR, over the same time period.