A good EMD manager does what he promises (Roundtable EMD – part 3)

June 11, 2025

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

EMD offers opportunities for investors who know how to strategically balance risk and return. To what extent is sustainable investing in EMD possible without compromising on returns? And what makes a good EMD manager? These questions were discussed during the third part of the Round Table organised by Financial Investigator with four experts and chairman Harry Geels, Senior Investment Advisor at Auréus.

By Hans Amesz

This is part 3 of the report. You can read part 1 here and part 2 here.

What actually makes a good manager in this asset class? Is there a big difference in returns between managers?

Van Wersch: 'It is particularly important that a manager does what he promises, i.e. practises what he preaches. We look for consistency and predictability in both investment theory and execution. If a manager says he avoids a certain risk, this must also be reflected in the performance attribution and analysis. If these deviate from their own convictions, that is a red flag for us. In addition, the size and quality of the team are obviously important, as is the interaction between portfolio managers, analysts and traders. We are not in favour of managers with a compelling “house view” that drives the entire portfolio. For us, working with like-minded managers on sustainability is very important.'

Nartey: 'A good fund manager must be able to generate alpha throughout the cycle, in good times and bad. And that alpha must come from multiple sources, not just from a macro perspective. We see EMD as an inefficient asset class, which offers opportunities through, for example, fundamental analysis, undervalued countries, structuring positions and the use of derivative instruments such as CDS (Credit Default Swaps). Diversification is crucial. An overly concentrated portfolio with two or three dominant positions is risky, because one mistake can ruin the entire year's performance.'

Friederich: 'Consistency in the investment team and in the approach is very important. Our lead portfolio manager has been successfully running our leading EMD fund, which ranks in the top 10%, for twenty years. With our stable, proven investment philosophy, we aim for stable alpha per year and limit drawdown risk.'

Drijkoningen: 'We pay attention to the well-known Ps: people (quality of the team), process (investment approach), performance, philosophy, platform (organisation, culture). You not only have to be strong now, but also future-proof with an eye for innovation, such as AI tools and geopolitics. Organisational stability is also important. If teams fall apart, it's disastrous.'

How do you view passive investing in EMD? Is there room for ETFs or index funds?

Nartey: 'Active clearly outperforms passive in EM. The median active manager outperforms the median passive manager. Capital gains taxes and withholding taxes on coupons are real costs for passive investors, but they are not reflected in the benchmarks that passive managers typically use. Active managers can avoid some of that tax burden, for example through derivatives. Passive investors have to rebalance every month at often unfavourable prices, while active investors can spread their rebalancing over a number of days. We also use CDS instead of cash bonds when CDS spreads are more favourable.'

Van Wersch: 'We invest a certain percentage of the PFZW portfolio in EMD local currencies using a passive-plus approach. The aim is to achieve the benchmark return after deduction of costs. We have selected investment teams that are capable of doing this, partly by making smart use of market inefficiencies that arise on a regular basis. An important component of the return is the “term premium”. This is supplemented with instruments that exploit differences in returns between, for example, supranationals and government bonds. We call it passive-plus because there is no active portfolio positioning based on a macroeconomic view, but rather smart execution.'

Drijkoningen: 'ETFs for local currency EMD are lagging behind benchmarks, mainly due to tax effects. When comparing local EMD managers, you should therefore not only look at the benchmark, but also at the comparison with ETFs as an alternative in order to compare apples with apples. ETFs are useful for tactical allocations or when you want to gain exposure quickly. They are less suitable for ESG implementation.'

Friederich: 'The benchmarks are quite concentrated. This means that they are risky in terms of passive investing. As an active investor, you can reduce risk and achieve consistently better performance by managing risk exposure wisely.'

How are ESG considerations changing investor appetite and debt issuance in the EMD market? Are there trade-offs between achieving sustainability goals and generating returns? And do you also see headwinds from, for example, the United States?

Van Wersch: 'In hard currency, you see more green bonds or labelled bonds in emerging markets than in local currencies. We don't blindly accept the green classification. We use our own framework to assess this. For example, if a country with many coal mines issues a green bond, how 'green” is that country? Are the spending targets for those green bonds properly defined? This relationship is easier to determine for individual companies in emerging markets, partly because there may already be an engagement process with the company and greater transparency has been enforced.'

Drijkoningen: 'The market for labelled bonds is approximately $1,000 billion in size. That is considerably more than the entire European high-yield market, so it is really substantial. We only accept the various ESG, green and social labels if they pass our own due diligence. In addition, there are also multilateral development banks, MDBs, which issue bonds in local currencies with strict SDG alignment. We use these a lot in sustainable EM portfolios.'

So can you invest sustainably in emerging markets without compromising on returns?

Drijkoningen: 'Yes, usually. Sometimes you even get a premium because the 'green” issues are smaller or less liquid. In general, the returns are comparable to regular EM bonds. Sometimes there is no alternative, as with MDBs, so then it becomes more of a take-it-or-leave-it situation.'

Nartey: 'If you look at the benchmarks, ESG indices and regular EMBI or GBI-EM are not that different in terms of returns over time. You do see differences in certain years, for example if an ESG fund does not hold fossil fuels and commodities are performing well, but on average they are comparable. Sometimes idiosyncratic country factors can cause differences in returns. Nevertheless, I wouldn't say that there is a necessary loss of return as a result of pursuing an ESG strategy in the long term.'

Friederich: 'Our impact investing team is very clear: you shouldn't sacrifice returns for sustainability. You can generate returns and make an impact. We combine internally approved use-of-proceeds labelled bonds with regular EM bonds from ESG leaders.'

Do you also see political headwinds in practice?

Drijkoningen: 'We remain fairly detached from that, with one distinction. ESG risks are often financially relevant, or 'material”, so you have to include them in your investment process. That is not a political stance, but a logical and necessary risk assessment. In emerging markets, it is crystal clear that the quality of governance, social cohesion, health and education, all of which are ESG-related, have a direct impact on credit quality. In addition, we also have clients who want us to incorporate sustainability criteria on top of the financial objectives. We are able to do that.'

Van Wersch: 'In frontier markets in particular, there is a complex trade-off between country risk in a broad sense and the impact opportunities that arise in areas such as the energy transition.'