The reason for this change being that these emerging markets have outperformed the UK stock market and UK bonds market since September 2008.
Domestic infrastructure problems, inflation, currency fluctuations and political instability are factors likely to result in ongoing volatility. But, it seems emerging market debt can no longer be viewed solely in a negative light by investors.
The question facing funds investors is what this change means, overall.
Data from Financial Express enables the selection of funds that include sovereign debt in top ten holdings. Examples include: the Investec Emerging Markets Debt fund, the M&G Emerging Markets Bond fund and the Threadneedle Emerging Market Bond fund. What initially stands out in these portfolios is the prevalence of BBB ratings. The M&G Emerging Markets Bond fund has the largest weighting at 45 per cent, followed by Threadneedle’s Emerging Market Bond fund with 43 per cent and Investec’s Emerging Markets Debt fund at 39 per cent.
Performance of funds over 1-yr
Source: Financial Express Analytics
The Threadneedle Emerging Markert Bond fund was the only one of the three to hold only investment grade ratings as of 31 December, 2009, varying from A-BBB, the remaining funds ratings varied from A-CCC.
If we take a closer look at the three selected funds to see how they correlate against their relative benchmarks and indices – IMA Global Bonds, IMA Sterling Corporate Bond and the FTSE All Share - we can see that with an r2 of .088 per cent, the M&G Emerging Markets Bond fund has the strongest correlation against its relevant benchmark, while at 0.66 per cent the Investec Emerging Markets Debt fund has the weakest correlation.
Looking at Sharpe ratios, the Investec Emerging Markets Debt fund scores highest at 1.02 per cent during the period 31 December 2006 – 31 December 2009. The fund has achieved higher returns than the other two funds, albeit with a higher measure of volatility, although the Sharpe for the sectors overall suggests they are all generating additional return for each unit of volatility.
Over a three year period to 25 January 2010, the Investec Emerging Markets Debt fund returned 76 per cent, compared to the Threadneedle Emerging Market Bond fund which returned 41 per cent and the M&G Emerging Markets Bond fund which returned 38 per cent. It also outperformed its sector – IMA Global Bonds- by 45 per cent over the same period.
The Investec Emerging Markets Debt fund has also stayed solidly in positive territory in more recent periods returning 14 per cent and 12 per cent over one year and six months respectively, outperforming its benchmark by nine and three per cent. Meanwhile, the M&G Emerging Markets Bond fund returned -0.35 per cent and 10 per cent over one and six months respectively and the Threadneedle Emerging Market Bond fund returned six per cent and 11 per cent over the same period.
Despite the upgrade, intermediaries are still debating the 'pros and cons' of investing in emerging market debt.
Graham Toone, head of investment research at AFH Wealth Management believes emerging market debt has come of age and says he is keen on this type of debt, however he has some reservations regarding fixed interest: "We think the environment for fixed interest is going to be challenging, as it will be facing the headwind of rising interest rates due to inflationary concerns," he says.
"Because of the challenging facing fixed interest, we are more comfortable using consider a strategic bond funds, such as Schroder Strategic Bond & L&G Dynamic Bond, to obtain exposure to this asset class," he adds.
Meanwhile, Martin Bamford, managing director at Informed Choice, feels sovereign debt and corporate bonds have been overlooked in most portfolios at the moment due to "the limited number of funds operating in this area", but doesn't think an upgrade will change this.
"An upgrade alone won't encourage a surge in investing in this area, although it might increase interest amongst investors."
Bamford also says even with the upgrade to investment grade, there risk/reward balance is still unbalanced.
"There is no substantial reward compared to the amount of risk you are taking on. At the moment it’s an unnecessary addition to any portfolio," he says.