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Comment: Global emerging market debt funds continue to shine

Global emerging market debt funds have continued to perform well, according to the latest update on the sector by Standard & Poor's.<?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

Over the three months to the end of January the median fund for those debt funds denominated in dollars was 5.3% higher, while its counterpart for the euro denominated sector showed a 2.4% gain.

These positive returns reflect the continued strength of the emerging market debt sector in recent months. Emerging market bonds have enjoyed the dual benefit of improved economic fundamentals in many countries leading to higher credit ratings as well as increased buyer demand as investors have sought attractive returns in a historically low interest rate environment.

The latter development is reflected in a substantial increase in sizes for many funds. Based on a representative sample of funds in the euro sector, for instance, Standard & Poor's analysts found the average fund size soared by a substantial 43.1% to USD 146 million between October 2003 and February this year.

As the median movement for the period shows, little of this rise was accounted for by underlying market performance. A similar, but less dramatic trend, was also evident among dollar denominated funds, where an average 17.1% increase in fund size was identified over the same period.

For successful managers in the sector it was a matter of getting their regional and country selection right. With such a diverse market there was considerable variation in geographic and individual country returns.

S& P stated: "The top quartile ranking ABN AMRO Global Emerging Markets Bond Fund, for example, gained from its manager Raphael Kassin's shrewd support for Ecuador, Turkey and Venezuela, all of which contributed positively."

Bernt Tallaksen, manager of Thames River High Income Fund, another top quartile entrant over the latest review period, achieved his fund's performance by adding value across the portfolio in sovereigns, corporate and distressed debt, but also by his decision to have little exposure to any of the mainstream sovereign markets.

In contrast to the global trend, the median fund in the emerging European debt universe showed a loss of 0.4% over the three months to the end of January. Currency was a major factor affecting returns in this sector. The Hungarian forint and Polish zloty both weakened on the back of political instability in their respective countries. As a result funds with high exposure to local currencies, such as the Luxembourg domiciled Vontobel Eastern European Bond Fund, reported another disappointing quarter. Other funds, like the Austrian domiciled Raiffeisen Konvergenz Rent Fund, which includes some eurobond content in its portfolio fared better, but still lost ground.

With the spread between emerging market debt and US Treasuries currently close to all-time lows, there is considerable division of opinion among those managers questioned as to whether the contraction of spreads will continue. On the one side the team at ABN AMRO are bullish, arguing that a lot of emerging countries are showing increased political stability and have their own attractions to withstand significant switching to the US dollar when American interest rates rise.

By contrast Matthew Ryan and Mark Dow, joint managers responsible for the MFS Emerging Markets Debt Fund are more cautious. They consider the scope for spread tightening to be limited, believing that investors will still expect an additional premium for the increased volatility of emerging debt investments.
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