Fund Times: Developments in the Emerging-Markets Arena

Emerging-market country debt has seen significant changes in recent years, as PIMCO executive vice president Curtis Mewbourne explained in his recent Emerging Markets Watch column. For starters, natural-resource-rich emerging-markets countries have greatly benefited from record-high commodities price levels in recent years, which have resulted in both improved sovereign balance sheets and increased debt reduction in the sovereign-bond sector. Debt reduction in countries such as Brazil, Columbia, and Venezuela, for instance, has amounted to more than $30 billion overall this year, according to Mewbourne. This, when coupled with lower levels of sovereign-debt issuance, improvements in governmental balance sheets, and heightened credit-quality ratings, has highlighted the significant changes going on in this market.

As this market matures, he argued, investment opportunities will "fall mainly in two areas, namely corporate and local market investments." In fact, the growing corporate emerging-markets sector, according to Mewbourne, eclipsed sovereign-bond issuance for the first time ever in 2005. Overall, he stated: "The EM [emerging markets] asset class is undergoing an important structural change, namely an expansion of corporate financing and a migration from external to domestic financing. At present, these markets are still in the early phase of their development, and periodic volatility and sharp corrections can be expected. But over the long run, it is very likely that investors will want to migrate more of their allocations away from shrinking G-3 economies and toward many of these emerging market countries and companies."

We've also seen some other fund shops recently alter emerging-markets mandates to aid management in taking advantage of this changing market landscape. AllianceBernstein Emerging Market Debt (AGDAX), for instance, changed its mandate in late 2005 to allow investment in non-U.S.-dollar denominated debt. Previously, it could only hold emerging-markets issues denominated in dollars. Additionally, the fund also holds a 19% position in corporate emerging-markets bonds. As markets continue to evolve and change, it will be the funds that can best adapt to these changes that will find success.

Timing Your Dollar-Cost Averaging
A paper in the Fall 2006 issue of The Journal of Wealth Management, by John Paglia and Xiaoyang Jiang, argues that you can market-time your dollar-cost averaging contributions. This may seem counterintuitive to many, because dollar-cost averaging strategies (where investments are made in regular amounts at fixed intervals in time) are typically seen as an alternative to market-timing, which history suggests investors perform poorly. The authors suggest that the date of the month on which investors contribute money can affect their longer-term portfolio return outcome.

Studying a period from Jan. 1, 1990, to Dec. 31, 2005, the authors concluded that "the best day of the month to invest in NASDAQ, Dow Jones Industrial Average, and S&P 500 is the 23rd day of each month. For all three indices, the average portfolio returns consistently invested on the same day between the 22nd and 25th of each month are higher than the rest of the month." They ascribed this effect to the biweekly payment schedules followed by many American companies. Of course, like with many historical market phenomena, just because the strategy has worked in the past does not mean that it will continue to operate in the same way going forward. This would be particularly true if institutional investors attempted to take advantage of the effect, which over time may make its usefulness more muted.

High-Yield Default Rates Remain Low, but for How Long?
Default rates of below-investment-grade bonds, also known as "junk bonds," have been near record lows lately, but the question on everyone's mind is how long it will last. Moody's Investors Services recently reported: "a 1.72% global issuer default rate for the trailing-twelve month period ending July 2006. This represents a marginal change from the 1.78% reading a month ago. U.S. defaults came in at a 2.26% level during the period, while Europe produced a 0.53% reading. ... The agency recorded a single default event during the month of July--that of Vesta Insurance Group. The company missed a coupon payment on its 8 3/4 senior debentures."

Going forward, however, Moody's expects to see a global issuer default rate of 2% by year-end and 2.7% in 12 months, as the credit cycle shifts. Several managers of high-yield bond funds have had modest concerns about possible increases in the default rate should the economy slow in late 2006 and 2007. They have argued that the yields on many high-yield bonds are not adequately compensating investors for the risks they're taking. Consequently, a number of managers in the group are shifting to higher-rated issues.

Management Change at Evergreen's High-Yield Bond Team
Evergreen Investments (Wachovia Corp.'s investment management business) recently announced that Gary Pzegeo, high-yield strategy specialist, has been named managing director and interim head of the high-yield bond team. He will replace Dana Erikson and Richard Cryan on several of the firm's high-yield offerings, as Erikson and Cryan are departing Evergreen. Pzegeo succeeds Erikson on Evergreen High-Yield Bond  (EKHAX), Evergreen VA High Income, and closed-end fund Evergreen Income Advantage (EAD). He also will replace Erikson as comanager on Evergreen Strategic Income (EKSAX), Evergreen VA Strategic Income, and Evergreen Managed Income Fund ERC, another closed-end offering.

Additionally, Pzegeo replaces Cryan as lead manager on Evergreen Select High Yield Bond  and as comanager on Evergreen Diversified Bond  and Evergreen Utilities and High Income, a closed-end offering. Pzegeo has considerable experience managing fixed-income portfolios, having served as lead manager to several Evergreen funds in the past. He will remain at these posts until someone can be found to permanently fill these positions.