Templeton Sees Positive U.S. Real Yield as Sign to Buy Emerging Markets

Franklin Templeton’s Mohieddine Kronfol is joining the ranks of fund managers scanning for signs it’s time to pile into emerging markets left battered by the Treasury-led selloff.

U.S. 10-year real yields above zero will be the trigger for the Dubai-based chief investment officer for Middle Eastern and North African fixed income. He’ll be watching to see which bonds get punished most in the ensuing slump.

It’s an approach that’s proving popular with some of the world’s biggest investment firms, from JPMorgan Asset Management to Ashmore Group Plc. They’re betting any turmoil will be a temporary setback as vaccine efficacy and President Joe Biden’s stimulus package power a global economic upswing.

Templeton Sees Positive U.S. Real Yield as Sign to Buy Emerging Markets

“We’re going to go to wherever there’s the most value,” said Kronfol, who now has almost a fifth of his portfolio in cash and super-short maturities. “We suspect the value is going to be in the longer-end of issuers from the region.”

The U.S. real yield -- which subtracts out inflation -- serves as a popular gauge to judge how attractive riskier investments are in relation to Treasuries. It still has a long way to go, and was at minus 0.7% Wednesday, compared with about minus 1% a month ago.

But Kronfol, whose Gulf Arab bond fund outperformed 90% of peers last year, is confident it will get there, albeit temporarily.

“The momentum is certainly supportive for short-term inflation to pick up -- but there’s an open question on how sustainable that’s going to be,” he said.

While higher U.S. real yields signal the economy is gaining traction, developing nation markets could suffer if the increases of recent weeks dim the appeal of assets that benefited from negative real rates.

Treasuries pared earlier losses Wednesday after a key measure of U.S. consumer prices rose less than expected in February, suggesting broader inflationary pressures remain tame. The 10-year yield was up two basis points at 1.54% as of 9:07 a.m. in New York. The average spread on emerging-market dollar bonds was little changed.

‘Temporary Pullback’

Investors should seize on “any temporary pullback associated with the ongoing transition to normality to add to positions in emerging markets, particularly in local markets,” Ashmore’s head of research, Jan Dehn, and deputy head of research, Gustavo Medeiros, wrote in a note.

Treasury Secretary Janet Yellen on Monday dismissed fears that President Joe Biden’s $1.9 trillion pandemic-relief bill would cause the economy to overheat and fuel a surge in consumer-price pressures. Federal Reserve Chairman Jerome Powell reiterated last week the central bank’s plan to stick with easy-money policies.

In anticipation of higher U.S. yields, Franklin Templeton’s Kronfol began in September to trim the fund’s positions in longer maturity investment-grade sovereign debt, reducing its duration to six years from about nine years. He also boosted the proportion of cash and securities with maturities of less than a year in his Gulf Cooperation Council bond fund to about 17%, from typical levels of 2% to 4%.

While foreign investors remain underweight in GCC bonds relative to the global benchmarks, rebounding oil prices, combined with improving fiscal and economic outlooks, mean the Gulf Arab region would be one of the first to recover should risk appetite sour, Kronfol said.

“With the higher oil price, I hope the region won’t slow down or stop the reform momentum,” Kronfol said. “You don’t want them to lose that momentum and lose credibility in the eyes of investors.”

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