Harbor Funds | Manager Commentary

News & Commentary

Emerging Markets Debt Fund —
Improved investor sentiment helps lift emerging markets bonds

1st Quarter, 2012

"Emerging markets fundamentals are still very strong. "
– Whitney Cox

Improving global economic data and diminished concerns about European debt problems provided a favorable climate for emerging markets bonds in the first quarter of 2012. The Harbor Emerging Markets Debt Fund posted a return of 7.39% for the quarter, compared with a 6.28% return by the broad emerging markets debt market, as measured by a blended index composed of 50% each of the JPMorgan Emerging Markets Bond Index - Global Diversified Index, and the JPMorgan Government Bond Index - Emerging Markets Global Diversified.

The rally reflected an improvement in risk appetite compared with the second half of 2011, when markets came under significant pressure, says Whitney Cox, Portfolio Manager, Emerging Markets Debt, for Stone Harbor Investment Partners, subadviser for the Harbor Emerging Markets Debt Fund. Investments in corporates and foreign exchange, rebounding from sharp declines in 2011, were important drivers for Fund returns in the quarter, she reports.

Looking ahead, the outlook for emerging markets remains positive, Cox says, although the investment team continues to watch closely for signs of weakness in the U.S. and European economies. Although its pace has slowed, economic growth in emerging markets countries continues to outperform economies in the developed world, she notes.

Whitney Cox's comments were made in an April 17, 2012, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2012, unless otherwise indicated. All references to year-to-date are for the period January 1 through March 31, 2012.

Interview Highlights

Continued volatility

While liquidity injections from the European Central Bank capped risk aversion in the first quarter, European sovereigns are still not out of the woods, and we have yet to see the effect of fiscal austerity plans. It's likely that we continue to see volatility out of the region over the next few months, and we are beginning to see the evidence of that as European sovereign bond markets come under pressure.

Strong fundamentals

Emerging markets fundamentals are still very strong. While growth has declined in emerging markets along with the rest of the world, compared to the developed world those growth differentials are still very high. Additionally, governments in most emerging markets countries have more to stimulate their economies through fiscal and monetary policy than developed market counterparts.

Improving credit quality

While we have not changed the portfolio allocation to corporate debt we have been gradually increasing the credit quality. Last year approximately 70% of our position in corporates was in high yield bonds. We have since reduced that position to 55%.

Cautious outlook

While we continue to be constructive on emerging markets, there is a risk of volatility in the near-term against the backdrop of declining global growth, and further European instability. The lack of clarity in that may drive the market lower or higher and has driven us to become more neutral in our portfolio positioning.

Regional positioning

We continue to be underweight in Eastern Europe versus an overweight in Latin America. Latin America is more attractive from a valuation perspective and is home to economies that are better positioned to weather further stress in Europe. Although we are constructive on Asia from a structural perspective, valuations are not particularly compelling, resulting in an underweight position in the region.