Some currencies, such as the Kazakh tenge, have upside potential in the longer term, says Jetro Siekkinen of Aktia. Photo: Astana, Capital of Kazakhstan Source: iStock, huseyintuncer

Weather the crisis better with frontier government bonds in local currency

Author: Jetro Siekkinen

In turbulent times, frontier markets remain attractive, says Jetro Siekkinen from Aktia Asset Management. Using the example of the UI-Aktia EM Frontier Bond+, the Deputy Managing Director explains his view in an interview and describes how the market has fared. The fund invests in local currency government bonds from countries that, in terms of their economic, political and capital market development, are not traditional emerging markets now but soon could be: these are the “leading developing countries of tomorrow”. The fund uses only financial instruments that are issued in local currency.

Jetro Siekkinen, Deputy Managing Director, Head of Portfolio Management, Aktia Asset Management Source: Aktia Asset Management

What started as a local crisis in a far corner of China reached global proportions within a few months and touched every continent. Politicians from industrialized and developing countries across the globe responded by introducing broad financial stimulus packages to underpin the economy and liquidity. These fiscal and monetary measures have offered some stability and liquidity has improved.

Oil – quo vadis?

The collapse of oil prices dealt a further blow to global markets: oil prices are now close to their lowest levels since 2000.

It looks at this stage as if the balance of supply and demand for oil will be disrupted for a long time to come. As a result, oil-exporting countries with large funding requirements, such as Angola, Bahrain, Ecuador, Gabon, Nigeria or Oman, have suddenly been confronted with a huge sell-off of their external debt. Their currencies have shown signs of weakness.

Strategy and Review: UI - Aktia EM Frontier Bond+

Against this extremely uncertain backdrop, the UI - Aktia EM Frontier Bond+ has performed very well compared with traditional local currency emerging market bonds: since the beginning of the year it has generated an alpha of 7 per cent (as of May 5th 2020). The total return of our strategy has been marginally negative (minus 2 per cent) compared with the beginning of the year (since January 2nd 2020) but is far stronger than the benchmark index GBI-EM Diversified (minus 9 per cent). Since the launch of our frontier strategy in 2015, the fund’s total return has outperformed those of traditional local currency emerging market bonds: 23 per cent versus 10 per cent since its launch and 5 per cent versus 2 per cent p.a. So far this year, the total return of our frontier fund has been weighed down by 4 per cent by the currency component, while the fixed-income component has shown a positive return of plus 2 per cent (as of May 5th 2020). 

Since 2015, the strategy has delivered far stronger returns than traditional emerging market bonds in local currency.

Jetro Siekkinen

The main reason that the frontier market return outperformed traditional emerging market bonds is that there are few if any passive products – ETFs - that track frontier countries. Foreign capital flows into the fixed-income markets of frontier countries are therefore comparatively low. As a result, there was no panic selling and there was no “tourist” money that could be withdrawn quickly anyway. The strategy’s attractive running yield was another factor. 

We have reduced our exposure to oil-exporting countries this year, as well as completely sold off our position in Nigeria. This was due to our growing concerns regarding oil price developments, currency valuations and shrinking currency reserves. We have increased our allocations to oil-importing countries such as Ethiopia, Georgia, Pakistan and Uzbekistan.

Still attractive: Frontier Markets 

The advantages of frontier market bonds are the current high yields (an average of 13 per cent as of April 29th 2020), the short duration (2.1 years) and strong average rating (BBB). Overall, we consider the frontier currencies to be neutrally valued. After the market developments of recent months, a further devaluation could be triggered by country-specific factors but we believe the risks of this happening are relatively low. We continue to take a negative view of the currencies of oil-exporting countries such as Angola and Nigeria. On the other hand, we believe that some currencies from countries such as Georgia, Kazakhstan, Pakistan or the Ukraine have upside potential in the longer term, particularly because foreign investments into these markets are currently at a low level. Considering the persistent high yields across the curve and the currency valuations, we continue to see the frontier markets as an attractive investment opportunity and a strategic core component of an EM income portfolio - for additional diversification through exposure to further regions and currencies with high growth potential. 

Author: Jetro Siekkinen
Date of issue: 5/14/2020