As published in Reuters Market News, October 10, 2012

RPT-Emerging market bond funds post standout performance in Q3

by Sam Forgione and Jennifer Ablan

NEW YORK, Oct 9 (Reuters) – The flagship funds of closely watched bond firms PIMCO and DoubleLine drew the most new money in the third quarter, but emerging markets bond funds grabbed the spotlight with their higher yields and strong performance.

The PIMCO Total Return Fund, the world’s largest mutual fund with about $278 billion in assets, attracted roughly $6.25 billion in new money in the third quarter, according to Morningstar.

Meanwhile, the DoubleLine Total Return Bond Fund was second with $4.45 billion in assets. It leads all bond funds this year with nearly $16 billion in investor inflows.

But for investors seeking yield when the 10-year U.S. Treasury note is hovering around 1.71 percent, the best place to be this year has been in an emerging market bond fund. The Barclays Capital Global Emerging Markets Index is up 15.10 percent this year, compared with a 3.77 percent gain for the Barclays Aggregate Bond Index – a far broader measurement of bond performance.

One of the standout emerging market funds is the TCW Emerging Markets Income Fund, which attracted nearly $784 million in new money in the third quarter, the most among emerging market debt funds, according to Morningstar. The TCW fund, part of the Los Angeles-based TCW’s stable of mutual funds, is up 16.17 percent this year, beating the 14.62 percent gain in the Standard & Poor’s 500 Index.

“The emerging-market story is more than just about ‘yield,’” said David Robbins, portfolio manager for TCW Emerging Markets strategies. “It is a long-term credit improvement story.”

In the late 1990s, roughly 10 percent of emerging-market countries’ bonds were rated high-quality investment grade. To date, more than 60 percent of emerging-market debt carries investment-grade ratings.

Emerging markets have been the darling of the financial world since 2009 as global investors have pursued stronger returns. The demand for emerging markets debt has been driven by a belief that countries such as China and Brazil would lead global growth in the next few years, while economies in the developed world would remain nearly stagnant.

But this year, China’s economic growth began to slow down more than expected.

“I think everyone knew that China would not see 10 percent GDP forever,” said William Braman, chief investment officer of Ballentine Partners, in Waltham, Massachusetts. “China is still posting solid growth relative to other countries.”

Braman said the firm has been rotating out of U.S. equities and into emerging market securities. He said the economic growth prospects look better in emerging markets at 6 percent versus developed countries at 2.5 percent.

NO LONGER EMERGING MARKETS?

The sector is the highest performing among bond types, said Jeff Tjornehoj, head of Lipper Americas Research, in Denver. The funds that hold emerging market debt are reaping the rewards, he noted.

Emerging market bonds could even oust “junk” bonds as this year’s debt darling as some analysts say that high-yield debt is starting to look overvalued and higher risk, compared with emerging market debt.

Investors are looking at emerging market bonds as a “true substitute” for investment-grade bonds, said Luz Padilla, a portfolio manager for the DoubleLine emerging markets fixed- income fund, in a webcast on Tuesday by the Los Angeles-based company.

So far this year, high-yield funds worldwide have gained $63.7 billion in assets while emerging market bond funds have gained $39.9 billion, fund-tracker EPFR Global said.

Padilla said the move into emerging market debt as a “flight-to-quality trade” is “well-justified.” She also cited the strong fundamentals of emerging economies and how they continue to strengthen despite the European debt crisis.

Padilla added that emerging markets could be less susceptible to a global economic slowdown, which the International Monetary Fund recently warned about when it cut its growth forecasts for the second time since April.

“If the situation in the developed countries continues to deteriorate further, a situation that the IMF recently stated has a one-in-six chance of occurring, emerging market countries have room to implement growth-supportive policies as their fiscal deficits average a mere 1 percent versus over 5 percent for the developed markets,” Padilla said.

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