Blended or separate mandates in EMD? (Roundtable EMD – part 2)

June 5, 2025

_{This report was originally written in Dutch. This is an English translation.}

Government bonds denominated in hard currencies have historically exhibited a riskier profile than government bonds denominated in local currencies. Are there economic cycles in EMD? During a Roundtable organised by Financial Investigator, four experts discussed this topic under the chairmanship of Harry Geels, Senior Investment Advisor at Auréus.

By Hans Amesz

This is part 2 of the report. You can read part 1 here, and part 3 will be published on Wednesday 11 June.

If you manage a portfolio, do you recommend a broad mandate that includes everything (local, hard currency, frontier, corporates) or separate mandates for each segment? And should that be active or passive?

Van Wersch: 'We have just implemented a global credit strategy with three dimensions: return, risk and sustainability. We combine investment grade corporates and high yield corporates in developed and emerging markets. So we have a global credit mandate that we allocate to internal and external investment teams. With investment grade, you can focus on labelled bonds, while with high yield we focus on engagement with issuers and try to make them more transparent. The energy transition is largely taking place via EM corporates. There are many opportunities there. We have a separate mandate for government bonds in emerging markets, in local currency. We do not combine this with corporates in emerging countries, because that asset class has different risk characteristics and it is also more difficult to engage with governments than with companies.'

Is this global credit strategy, with a portfolio for emerging and developed markets, split into investment grade and high yield, unusual?

Van Wersch: 'We think so. Most investors still think in terms of so-called silos, in investment grade or high yield in developed and emerging markets. We believe in combining these asset classes into a single integrated mandate. This allows you to create the largest possible universe in which the 3D balance between return, risk and sustainability can be optimally achieved.'

Nartey: 'We offer both separate mandates (local or hard currency) and blended strategies. ESG variants are also available. In separate mandates for hard currency, we often include corporates because they can add value, even if they are not in the benchmark. Of course, they often entail risks, but these can turn out to be advantageous.'

Friederich: 'Our philosophy is that it is difficult to manage local and hard currencies well together in a single fund. Research shows that blended funds often perform less well than hard currency-only funds. That is why we prefer a separate fund for both hard currency and local currency. However, we do add corporates to hard currency funds if this offers a better risk/return ratio. For example, in countries where spreads on government bonds are low, but corporate bonds offer attractive spreads.'

Drijkoningen: 'In practice, you see that if EMDs make up a small part of the total portfolio, investors prefer a blended mandate because it is simply easier. However, you do have to demonstrate that this approach adds value. Blended portfolios are often better diversified. Moreover, a blended mandate makes it easier to reallocate risk budgets between, for example, an attractive local currency and a less attractive hard currency in the same country.'

Blended portfolios have many sources of alpha. Can a manager oversee all of that?

Drijkoningen: 'Transparency is important. You need to be able to explain clearly where the risk comes from and where the performance is generated. Whether this is done adequately depends on the organisation. With blended strategies, you often see larger teams with a clear division of tasks. You can also do it with a small team, but then the coverage is more limited.'

Friederich: 'We have a team in which traders, portfolio managers and analysts work closely together. Everyone knows exactly what is in the portfolio, which helps to optimise the EMD portfolio and generate investment ideas.'

Van Wersch: 'When we developed our global credit strategy, we specifically looked for managers who could combine all segments: investment grade, high yield, emerging market debt and ESG. You don't want a separate silo approach, but an integrated platform.'

Is there a kind of market phase or economic cycle in EMD and do you try to steer for that?

Van Wersch: 'Managing the cycle is very difficult. High yield managers in particular are often defensive, with low beta. But that rarely works out well. They say they earn less in a bull market and compensate for that by losing less in a bear market, but that's often not true. What we are looking for are managers who can steer the portfolio with a beta of around 1, i.e. move with the market, but add value through security selection. They should not try to time duration risk; that is not what we pay them for.'

Friederich: 'We focus on fundamental bottom-up analysis per country through our country cohort approach for our flagship EMD fund. If we classify a country as “steady” because of stable fundamentals, but government bond spreads are low, we often look at corporates within that country. The same applies to “reformer” countries, which generally have attractive corporate bonds. We usually avoid “laggards”, i.e. countries with deteriorating fundamentals, unless the valuation is particularly attractive. We look at “crisis-hit” countries, such as Zambia last year, when there is a clear prospect of restructuring. Finally, there are the frontier countries, where our sovereign expertise finds the best alpha opportunities within government bonds. As for the EMD cycle, cash positions are relatively good at the moment and many restructurings have been completed.'

Nartey: 'We want to be an all-weather manager. That means delivering consistent alpha, whether the market is rising or falling. Some managers thrive in a bull market but underperform in a drawdown. This performance dynamic is the result of running a portfolio with a high beta, but that is not our approach. We usually keep our portfolio betas between 0.9 and 1.1. We do not try to generate significant amounts of alpha from beta exposure, but instead focus on bottom-up country selection, security selection and yield curve positioning. That is a better way to generate consistent alpha throughout the cycle, rather than simply leveraging beta. Bottom-up alpha is generally more consistent than macro positioning or beta leverage.'

Drijkoningen: 'We use top-down insights as part of the risk budget. For example, when central banks tighten policy, you quickly see that reflected in the financing costs for emerging markets. Valuation also plays a role: when spreads are extremely low, the chance of negative returns is greater than when spreads are high. That translates into how we deploy risk, namely more at high spreads and less at low spreads.'

Van Wersch: 'Our analyses show that duration and FX are not consistent sources of alpha in corporate credit. We prefer to focus on fundamental bottom-up credit analysis.'