Catching absolute return opportunities in emerging markets

It is difficult to judge the potential and sustainability of the various absolute return approaches and products. Investors must identify the objective of the strategy/product, and what the strategy can reasonably deliver in different market environments, especially times of high stress when capital preservation is most needed.

Even if an absolute return product has historically delivered attractive returns, investors must consider the market circumstances in which these returns were delivered. A multi-strategy approach combining different sources of performance generation and driven by different risk factors results in a portfolio with low directional risk. Market conditions and opportunities change over time, and managers must have the flexibility to increase risk when the market compensates generously for it, and reduce it when valuations are stretched and the market does not offer adequate compensation.

Fund vs. sector


Identifying dislocations in valuations from emerging countries, currencies and bonds offers attractive potential for investors in 2010. We believe that the following four themes will be important considerations for portfolio positioning over the next twelve months:

• Assessment of positioning within the economic cycle: after coming out of recession and entering the recovery cycle the largest part of the overall market driven performance is behind us. Going forward, selection will be crucial, as valuations do not offer room for inaccuracy.

• Assessment of positioning within the monetary cycle: interest rates worldwide are at historically low levels. By identifying countries which will recover quicker and stronger than implied in current valuations will provide enormous opportunity for returns.

• Search for new funding currencies: valuation wise, the dollar weakening versus major G10 currencies appears to have levelled out. In order to catch the full appreciation potential of a selection of emerging market currencies it will be important to select the most appropriate funding/short currency.

• Dislocation in valuations: it is important to exploit dislocations in valuations among different instruments: bonds versus CDS (basis trades), local bonds versus interest rate swaps, and local currency bonds versus hard currency bonds are some of the relative trades that can be implemented.

A multi-strategy, macro and valuation driven approach combined with a suitable implementation is ideal to catch opportunities that the market will offer this year.

Enzo Puntillo is manager of the Julius Baer Absolute Return Emerging Bond fund. The views expressed are his own. No recommendations are implied.