One of the Hottest Emerging-Market Bond Trades Is Fizzling

(Bloomberg) -- For GAM UK, Vontobel, and Amundi one of the hottest emerging-market bond trades is starting to lose its charm.

Even as central bankers around the world push on with policy easing, some of the biggest developing-nation investors are warning the dash for duration is overdone. After offering six times the return of bonds with less sensitivity to interest-rate changes, high-duration debt has stumbled in the past five weeks on signs the rally may have gone too far.

“The risk is that it unwinds a bit,” said Paul McNamara, a London-based fund manager who helps oversee $9.4 billion in assets at GAM UK. “We really need significantly worse news for rates to continue to rally.”

It’s unclear if a soft U.S. jobs report on Friday would be enough to spur fresh interest after bonds with duration of at least 10 years handed investors an almost 24% return over nine months. According to Vontobel Asset Management, a pivot toward greater fiscal stimulus by governments could also eventually hamper the trade.

“Policy makers are changing and recognizing that monetary policy alone cannot do all the heavy lifting,” said Wouter Van Overfelt, a Zurich-based senior money manager at Vontobel, which oversees 128 billion Swiss francs ($128.6 billion) in assets. “When it happens, or when markets get the impression it will happen, rates will move up and so that is why I think duration is actually a big risk today.”

After a 6% gain in August, bonds with a duration of at least 10 years flipped to a 1.4% loss last month. That compares with a 0.5% gain for debt with duration of zero to 1 year, according to a Bloomberg Barclays index tracking dollar-denominated debt. Those losses have extended into October.

Headwinds Remain

Not everyone agrees the trade is fizzling.

A host of headwinds, from weak U.S. manufacturing data to the U.S.-China trade war and Brexit mean inflation will remain elusive and rates may go lower still, fueling the hunt for yield.

“The environment is still positive for duration,” according to Stuart Ritson, an emerging-market bond fund manager at Aviva Investors in Singapore. “Global growth continues to weaken, particularly in the manufacturing sector, and inflation is still low almost everywhere, and we’ve got continued easing by global central banks.”

Ray Jian, London-based portfolio manager and head of emerging-markets aggregate debt at Amundi Asset Management, is long duration versus his benchmark, but has been trimming the position since the summer.

He cites the risk to the trade from a possible breakthrough in trade talks, which would send yields higher. Chinese Vice Premier Liu He visits Washington for negotiations with his U.S. counterparts next week.

“We believe most of the rally is behind us,” Jian said.

To contact the reporters on this story: Selcuk Gokoluk in London at sgokoluk@bloomberg.net;Lilian Karunungan in Singapore at lkarunungan@bloomberg.net

To contact the editors responsible for this story: Dana El Baltaji at delbaltaji@bloomberg.net, Alex Nicholson, Srinivasan Sivabalan

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