Portfolio Manager Perspectives

Jeff Benjamin

Uncovering yield in emerging markets not for the faint of heart

Katherine Renfrew talks about balancing risk and reward while going off the beaten path

Oct 18, 2019 @ 2:19 pm

By Jeff Benjamin

Katherine Renfrew is the lead portfolio manager of the $530 million TIAA-CREF Emerging Markets Debt Fund (TEDNX), which has a five-star rating from Morningstar and has been a top percentile performer over the past 1-, 3-, and 5-year periods.

While Ms. Renfrew insists the fund is not designed to "swing for the fences," there are constant efforts by the management team to push for alpha in the kinds of markets a lot of investors would fear to tread.

Jeff Benjamin: Why should people be investing in emerging market debt?

Katherine Renfrew: If you have a fixed income allocation and you want some diversification with enhanced yield, this is a place to get long-term risk-adjusted positive returns.

JB: Specifically, what makes the emerging markets so appealing?

KR: It's diversified, there's growth, you can get positive yields not negative yields.

The performance has been very attractive because it's still a growing market that hasn't been saturated.

JB: Should investors in this fund be expected to be exposed to below-investment-grade debt?

KR: Yes, but not exclusively. Our benchmark for this product [JPMorgan Emerging Market Bond Index] is a double-B-plus rated index. With that in mind, it's about half and half but skewed to high yield with some defaulted securities in the benchmark.

While we don't invest exclusively in high yield, I think investors in this product should not be surprised to find high yield securities. But these are generally fairly liquid products that do have an active market behind it.

JB: Your fund is a top percentile performer over the past 1-, 3- and 5- year periods, but there was some slippage last year when the fund declined nearly 6% and finished in the 65th percentile. Can you explain what happened?

KR: At year end 2018 there was a bit of a liquidity bubble where it impacted a lot of the credit markets. We saw some selloff in some of the high yield product, and we do have a credit orientation where we're not averse to taking risks

I think we had some Asian high yield that detracted at the end of the year. By that point some of the Turkish corporates had started recovering. We did have Turkish corporate exposure that sold off dramatically last year in the mid-year time frame, and we had not exited quickly so we were able to ride back a pretty healthy recovery. But overall during the year that exposure was a bit of a drag.

I wouldn't say we had an excessive amount versus our peers but it was probably enough to impact some of the performance.

JB: Is this fund designed to hold an even balance of sovereign and corporate debt?

KR: If you look at the index we start with as our benchmark, a portion is in quasi sovereigns, which are not guaranteed but they are entities that are often affiliated with the government.

The balance of the benchmark is 80% sovereign and 20% corporate.

Our fund has been operating at 50% corporates, but that includes the quasi sovereigns, 40% hard currency sovereigns and 10% local currency sovereign.

The local currency sovereigns are not included in the benchmark and you're taking that additional currency risk.

It's a mix of 50% corporates, some of which are in the benchmark, but 40% are not.

JB: How do you decide where to invest?

KR: As the lead manager, I give an allocation to our sovereign team and they try to beat their constituents in the benchmark.

For our corporate team, our analysts are evaluating the opportunities and flagging what they view as attractive in their region, and as the portfolio manager I make sure I'm comfortable with the country risk and risk profile and that we're getting a sufficient amount of spread versus other similarly rated countries across the spectrum.

A lot of these countries have quasi sovereigns, and our corporate team is often very good at identifying things that are not necessarily benchmark opportunities but additional incrementally higher-returning types of investments. They can often be high yield, or they can just be well-priced and expected to perform on a short-term basis

JB: Morningstar lists this fund's annual turnover rate at 75%. Can you explain what it's so high?

KR: I don't think it's that high. We need to be mindful of daily inflows and outflows from our client base. More importantly, there's a new issue premium that is often provided and since we get good allocations because of our size and the breadth of our presence in the marketplace, that lends itself to an edge.

So, when new issues come, if we're positioned appropriately where we can add some incremental attractive opportunities we'll invest. We're not always getting inflows, so you have to fund those opportunities.

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JB: What are the risk controls in place for this fund?

KR: We have an entirely separate risk management group. We have oversight committees that delve into our performance. But really, the portfolio managers are the first line of defense.

The nice thing is that I have an order management system platform where I can see the portfolio and all the characteristics on a daily basis, and on a minute-by-minute basis to ensure that both my partner and I are not liking the same country so much that we become concentrated.

Also, our process is that we don't increase our idiosyncratic out of benchmark bets more than the 150 basis points per entity.

And we rarely take more than a 5% overweight actively on benchmark countries.

Our local currency allocation is where we use up a lot of our risk budget because the higher volatility when it's out of benchmark tends to almost be two and a half times the actual allocation. I'm using 25% of my risk budget if I'm allocating 10% to an out of benchmark local allocation.

That means I have to feel that there are opportunities there that can add real positive alpha.

JB: You co-manage this fund along with Anupam Damani. How do you divide and share the responsibilities?

KR: I'm the lead portfolio manager. That means I set and determine the allocations whether it's across the different sectors, how much corporate out of benchmark we have, how much dollar risk versus non-dollar risk we're taking, how much we might stray from the benchmark in terms of either quality or duration. And ultimately, I have to be comfortable with the kinds of exposure she's invested in.

Then as a subsector specialist in corporates, I wear two hats. I do aggregation of the risk and make sure that we are, from a portfolio standpoint, in line with our tracking error budgets and in line with the various risk parameters.

Then as a subsector specialist I manage the corporate exposures.

In that respect we're co-PMs, where she manages the 50% that's the sovereign portfolio and I manage the 50% that's in corporates and quasi sovereigns.

JB: How do you feel about where we are in the current market cycle regarding emerging market debt?

KR: We've come full circle from the beginning of the year. We have pretty low U.S. Treasury rates, expectations for further cuts by the Fed, and very little inflation globally. I think that means it's favorable. The market conditions have been open, and we've seen a lot of issuance across the globe.

We have over 70 countries in the benchmark alone. That's good in that you have a lot of places to choose from with a lot of different kinds of characteristics.

There are economies that are open and there are economies that are more closed, and some are more sensitive to the global trade dynamics.

Others are in differences stages. That's another great qualification for being in emerging markets versus just U.S.-oriented fixed income. You only have one economy if you're a U.S. investor, and you have a lot to choose from if you're an emerging markets investor.

JB: Where are you seeing opportunities now?

KR: In terms of country exposure, we still like Brazil. It's been an area where we've been able to be invested in corporates and basically benefit from the additional spread that we're getting there.

We have also been involved in Indonesia and India corporates. That's been a good area of incrementally higher returns.

In the sovereign space, we've done very well by being early to the Ukraine story.

JB: Where do you see risk in the markets?

KR: There are some frontier countries that we have shied away from. Tajikistan is one that came to market, but our sovereign team didn't think it was priced appropriately.

Mexico is an area that we're watching, but for now we have not been as bullish or constructive on that country as we might be. But it's an area we need to maintain pretty rigid focus on.

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