Harbor Funds | Manager Commentary

News & Commentary

Emerging Markets Debt Fund —
EM debt weak in Q1 after strong 2012

1st Quarter, 2013

"We think emerging markets continue to be much better positioned on a fundamental basis than developed economies. "
– John DiSpigno

Following a strong performance last year, bonds from emerging markets countries retreated a bit in the first quarter of 2013. 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, posted a negative return of -1.19% for the three months ended March 31. This followed a calendar 2012 in which the blended index returned 17.18%.

Corporate securities managed a positive return and were the best performing sector of the emerging markets universe in the first quarter, reports John DiSpigno of Stone Harbor Investment Partners, subadviser for the Harbor Emerging Markets Debt Fund. Dollar-denominated government bonds lost ground while returns of local currency debt were essentially flat.

In this environment the Harbor Emerging Markets Debt Fund slightly outperformed the blended benchmark with a negative return of -1.04%. Among the bigger drivers of returns for the portfolio were an off-benchmark allocation to hard currency corporate debt and a smaller than benchmark allocation and favorable issue selection in Argentina, DiSpigno reports. An overweighted exposure to Venezuela also contributed to outperformance relative to the index.

John DiSpigno's comments were made in an April 12, 2013, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2013, unless otherwise indicated. All references to year-to-date are for the period January 1 through March 31, 2013.

Interview Highlights

Room for further gains

We still believe spreads have room to tighten. A lot of the negative returns in the first quarter were based more on technical factors than on any fundamental premise, in our opinion. Given slow economic growth and low yields in the developed world, we think the search for yield could help drive spread tightening in the emerging markets.

Favorable positioning

We think emerging markets continue to be much better positioned on a fundamental basis than developed economies. We would expect investment flows to strongly support spread tightening and currency appreciation within emerging markets because of what we believe are under-allocated levels of investment by pension plans, sovereign wealth funds, and retail investors.

Corporates attractive

In the corporate portion of the portfolio we think corporates are very attractive versus U.S. triple-B and double-B rated debt. Spreads are much wider and, in our view, represent better valuations based on credit quality.

Duration positioning

We're toward the shorter end of the yield curve in most of the portfolio. We think the end of the easing cycle is over and yield curves should start to steepen in response to growth and currency appreciation.

Redeploying assets

Compared with the benchmark, we're overweight in high yield corporates. This is based primarily on valuations. We have taken profits in some of our high grade Asian credits that have had a tremendous rally and reinvested the proceeds in higher yielding corporates. These are credits that we think not only provide a much higher yield for the risk we're taking but could be positioned for upgrades.