RISK MANAGEMENT AT RBC EM BOND FUND
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THE FUND INSIDE
Veteran business journalist and investigative reporter Olev Edur takes you behind the performance numbers for close-up look at the people, processes, and portfolios that make investment funds tick.
 



By Olev Edur  | Tuesday, November 06, 2018




Picking domestic stocks is tough enough, and picking fixed-income securities can be even trickier (unless of course you want to settle for a portfolio of low-yielding GICs). That’s why most retail investors will opt for fixed-income mutual funds and leave all the tough decisions to the professionals. But all those challenges are multiplied when making fixed-income choices in emerging markets. Still, some funds are up to the challenge, like the FundGrade A+® Award-winning RBC Emerging Markets Bond Fund.

Managers Jane Lesslie and David Nava at RBC Global Asset Management in Toronto have a systematic approach to running the portfolio that’s earned them a stellar average annual compounded rate of return of 7.9% over the 5-year period through Sept. 30, 2018 – well above both the emerging markets category average of 4.1% and the returns from most domestic funds, including equities.

One of the fund managers’ cardinal tenets is to avoid unnecessary risk and for the time being, that means avoiding corporate securities almost entirely. Lesslie explains that while government bonds account for 75% of the portfolio, and 21% is in “quasi-governmental” organizations such as Petroleos Mexicanos, corporate bonds now represent only about 3 1/4% (the remaining sliver is cash).

“Corporates in emerging markets can be quite risky, and right now they’re not worth the yield premium,” says Nava.

“You need a dedicated analyst who is familiar with those markets to look at all the new companies that are being created.”

Adds Lesslie: “Corporates are not all that exciting now from a risk/reward perspective. After the financial crisis when corporations were battered down, we were up to 30% [of total assets] in corporates. They were very attractive then, but less so now. There’s been an enormous issuance in the past few years as emerging market economies grow. But we like companies that have been storm-tested, so we know how they’ll deal with adversity, so we’re being careful about adding additional corporate securities.”

Nevertheless, caution is the watchword on the sovereign side as well. “The key is to avoid risk,” says Nava. “Don’t go somewhere just because they offer a higher yield. For example, we’ve started to buy in Argentina and Turkey because the yield now supports the risk. But you have to be very careful – it takes time to assess those risks. For example, Venezuela’s yields have gotten very attractive, and they keep going higher and higher, but given their problems, the yields could go even higher.”

In assessing the risk of emerging countries, the numbers are of course always important, as with any market investment. But in some cases the numbers aren’t exactly what they may seem, and that calls for broader information sources and added layers of analysis.

“We tend to look at countries in pairs,” says Lesslie. “There’s an institutional bias towards bigger economies, just because they have a bigger benchmark presence. For example, we’ll look at two B-rated countries such as Rwanda and Nigeria, the latter being one of the largest economies in Africa, and the former being one of the smallest. But Rwanda’s GDP per capita has risen 12% in the past four years, while Nigeria is down 7.2% despite rising oil prices. If you look at the World Bank ease of doing business statistics for 190 countries, Nigeria is ranked 145th, while Rwanda is ranked 41st – that’s a first-quartile performance, and it’s been improving steadily.

“Credit ratings are important too,” says Nava. “For example, with a market that has a triple-A bond rating, we can be a little more relaxed, whereas with single-B countries such as Ecuador or Argentina, we look more closely at the qualitative signals.”

Indeed, those qualitative signals are a major component of the vetting process. “ We are refreshing our model, so 20% consists of qualitative indicators, such as the World Bank’s data on the ease of doing business, and Transparency International measurements,” says Lesslie. “For example, Brazil’s corruption has an enormous cost, and Venezuela has lost an estimated $300 billion in recent years. We also look at the United Nations’ world governance indicators to see if improvements are for the benefit of all citizens or just a chosen few insiders. We look at MSCI’s environmental risk date. We turn all this into a matrix of environmental, social and governance risks.”

“We use 36 natural and qualitative indicators to see who’s really improving in growth, but qualitative measures are only one part of our analyses,” adds Nava. “ We look at domestic debt, budget deficits, and primary deficits [before interest costs]. We look at the banking sector. We look at the growth profile – is the growth a natural product, or are they supercharging the numbers by growing their bank debt? What are the external vulnerabilities?”

As for the overall difficulties of investing in emerging markets, Lessie suggests they are diminishing with time: “Conditions are dramatically improving in many emerging market countries, to the point where the differences between emerging and developed markets are starting to disappear.”

Olev Edur is an experienced financial and business journalist and a frequent contributor to the Fund Library.

Notes and Disclaimers

© 2018 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without written permission is prohibited.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the simplified prospectus before investing. Mutual funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

   
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