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Emerging Markets Debt Fund —
EM debt markets decline in Q3, reducing first half gains
3rd Quarter, 2014
"We think the experience we have gained in managing emerging markets debt since 1990 can create opportunities. "
– Stone Harbor Investment Partners LP

After generating positive returns in the first half of 2014, emerging markets debt securities gave back some of those gains in the third quarter. Bonds from developing economies posted a return of -3.15% for the third quarter, 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. On a year-to-date basis, the blended index returned 3.96% for the nine months ended September 30, 2014.
Despite their decline in the third quarter, emerging markets bonds outperformed international equities both for the quarter and on a year-to-date basis. Equities in developed overseas markets posted returns of -5.88% for the third quarter and -1.38% for the nine months ended September 30, as measured by the MSCI EAFE (ND) Index, while emerging markets stocks returned -3.49% for the quarter and 2.43% for the nine month period, as measured by the MSCI Emerging Markets (ND) Index.
The Harbor Emerging Markets Debt Fund returned -4.03% for the third quarter and 2.31% for the first nine months of 2014, lagging behind the blended index. The Fund is managed by Stone Harbor Investment Partners. A larger-than-benchmark exposure to sovereign debt in Venezuela hurt Fund returns relative to the blended benchmark for the third quarter, as did issue selection in Argentina, reports John DiSpigno of Stone Harbor Investment Partners. These factors were partially offset by favorable selection in Venezuela, as well above-benchmark exposures to local currency debt in Russia and Indonesia.
John DiSpigno's comments were made in an October 14, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended September 30, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through September 30, 2014.

Interview Highlights

Q3 drivers
I think the biggest issue is how the markets perceive the likely timing and pace of rate increases by the Federal Reserve. We still think the Fed won't begin to raise rates until the second half of 2015 but the markets seem to be indicating an expectation that it could come sooner. Coupled with the Dollar rallying, stronger economic data in the U.S., weaker numbers out of China and Europe, and weaker commodity prices, we believe those were the main factors influencing emerging markets over the third quarter and primarily in September.
Long-term perspective
We think the experience we have gained in managing emerging markets debt since 1990 can create opportunities. We believe we understand the cycles, we understand the governments, and we understand why they're much better positioned today than they were 10 years ago. Our view is that conditions don't warrant the sell-off that we've seen in emerging markets and that valuations at their current levels represent an opportunity.
Diverging views on Venezuela
Venezuela is a country selection that has been underperforming but the bonds that we own within Venezuela have outperformed. Bonds that mature in 2016 and 2017 are currently yielding in the low-20% range. The country on the whole has underperformed and is currently pricing as if it could go into default in the next six months. That is in contrast to our fundamental view of the country and its ability and willingness to pay.
Finding opportunities
Active management should benefit investors in emerging market debt in the months and quarters to come, in our view. We think it won't be benchmark driven. We expect to see significant differences among returns of countries over the next year – an environment in which overweights could make an important contribution to performance. Our view is that countries that have sold off for more technical reasons can present opportunities if you understand the fundamentals.

Performance data shown represents past performance, which is no guarantee of future results. Current performance may be higher or lower than the past performance data shown. Investment returns and the value of an investment will fluctuate, and an investor's shares, when sold, may be worth more or less than their original cost. You can obtain performance data current to the most recent month-end (available within seven business days after the most recent month-end) by calling 800-422-1050 or visiting

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The views expressed herein are those of the portfolio manager at the time of the interview and may not be reflective of their current opinions or future actions.  These views are not necessarily those of the fund company and should not be construed as such.

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