Executive Summary

♦ Emerging Markets Debt is a sizable and growing asset class offering much higher yields than traditional fixed income

♦ Given idiosyncrasies and exploitable inefficiencies, the asset class lends itself to active management

♦ Mondrian’s systematic and consistent approach to portfolio construction has yielded strong long- term results

♦ Current valuations, especially in local currency Emerging Markets Debt, are attractive.

1 – The Rise of Emerging Markets Debt

Over the past couple of decades, Emerging Markets Debt (EMD) has matured into a large, diverse and growing asset class. According to the Bank of International Settlements (BIS), there is currently more than US$20 trillion of emerging markets bond issuance outstanding – about a fifth of the total global fixed income universe. Within the most commonly followed indices, published by JPMorgan, there are more than seventy countries, with issuers including both sovereign and corporate entities. The strategic case for Emerging Markets Debt is in our opinion compelling. Firstly, it offers considerable potential for return enhancement and, secondly, it provides substantial diversification benefits.

Emerging market countries represent more than 80% of the world’s population, 75% of its land mass, more than 60% of its natural resources and more than 60% of its economic output; their debt markets cannot be ignored. Moreover, due to the idiosyncrasies of the countries involved and the inefficiencies of the asset class itself, our research suggests the Emerging Markets Debt asset class particularly lends itself to prudent active management.

In addition, we believe not only is the case for a long term strategic allocation to EMD compelling but the tactical case, given current valuations, suggests that the time is now ripe for entry.

2 – Anatomy of the Asset Class

The EMD asset class as a whole can be divided into four distinct sub-classes depending on the type of issuer (sovereign or corporate) and the currency of issue (domestic or external). Table 1 below shows the industry leading benchmark for each of these sub-asset classes along with the number of countries covered by that index, the amount of debt represented in that index and, for three of the indices, the assets managed to that index. By far the largest, most actively traded and therefore most liquid, segment of the market is in the sovereign sector and it is this that we focus on in this paper. However, it should not be forgotten that corporate debt is a significant part of our EMD opportunity set.

2.1 Hard Currency EMD

Hard currency EMD refers to the issuance of debt by emerging market countries not in their own local currency but in a so-called “hard” currency that is generally more acceptable internationally as a store of value and means of payment. Principally, such debt is issued in the hardest of currencies, the US dollar. Due to the manner in which global emerging markets debt evolved, hard currency EMD has a longer track record than local currency EMD, since less developed countries were initially compelled to borrow mostly in US dollars, a phenomenon known as “original sin.” The US dollar denominated bond market grew out of the Brady Plan from 1989 (named after US treasury secretary Nicholas Brady) that enabled a number of countries to restructure their bank debt after it became distressed in the 1980s.