OpinionQ3 2016

Emerging market bonds back in vogueFundamentals, technicals and ratings drive major inflows

The Muzinich Emerging Markets Short Duration Fund is celebrating passing the important three-year landmark. The Fund has delivered annual performance of 3.29%, with volatility of 1.67% (Sharpe ratio: 1.91). With more than US$275 million in assets under management (as at July 31 2016), the fund focuses on short-term corporate bonds in the emerging markets sector.

The popularity of emerging markets as an asset class is rising for the first time since the “taper tantrum” of May 2013. Recent weeks have seen record inflows for emerging market bonds, particularly those denominated in hard currencies, with inflows of US$3.2 billion in the first week of July alone.

There are several compelling reasons why bond investors are returning to the emerging markets sector and why short-duration bonds in particular represent an attractive proposition. Let us examine each of them in turn.

“ Short duration bondsare likely to offer anespecially soundrisk-reward profile for investors who wish to limit risk and volatility.”

Warren Hyland, MSc, CFA

Portfolio ManagerBased in London, Warren Hyland has 20 years’ investment management experience and joined Muzinich in 2013. Warren came to Muzinich from Schroders, where he was a Global Portfolio Manager and later, the Senior Portfolio Manager for Global Emerging Markets.

Warren has a BSc in Mathematics for Business from the Middlesex University London, and later received his MSc in Shipping Trade and Finance from the CASS Business School. He holds the Chartered Financial Analyst designation.

By Warren Hyland, Portfolio Manager, Muzinich Emerging Markets Short Duration Fund

The “growth gap” between emerging and developed markets is widening in the former’s favour. We expect emerging markets to grow by a robust 4.5% this year. One reason for this is that economies such as Russia and Brazil are now coming out of recession; in tandem, economies such as India and China are enjoying improved stability.

The recovery in commodity prices is also key to emerging markets’ renewed appeal. The apparent bottoming-out is good news for developing nations, which tend to be producers of raw materials. Growing signs of stability in this regard make it easier to promote projects and investments.

Stability and low commodity prices lead to little inflationary pressure, which can encourage Central Banks to reduce interest rates. Such a move is expected in the likes of Brazil, India, Indonesia, Russia and Turkey and is in keeping with the loose monetary policies at present favoured by the European Central Bank, the Bank of Japan and the US Federal Reserve.

It is interesting to note that numerous macroeconomic developments that originally shocked the financial markets have failed to play out as dramatically as initially expected. The Federal Reserve’s policy of a rapid rise in interest rates, the decline in China’s growth and the instability of commodity prices have all proved less significant than first feared. This further explains investors’ restored faith in emerging markets’ fundamentals.

Fundamentals: robust growth, greater stability

Technicals: strong dynamics

Although investor demand is rising, the net supply of bonds in the emerging market sector is declining. This has been the case since the beginning of the year, as a result of which the quantity of new issuances actually no longer covers the quantity of maturities, coupons and premature terminations. This represents an extraordinary situation.

The combination of an abrupt rise in demand and a contracting investment environment leads to inflows, which in turn lend themselves to strong technical market dynamics. Together with the attractive fundamentals discussed above, these significantly bolster the appeal of the asset class.

OpinionQ3 2016

What this means is that the vast majority of the investment environment is shrinking. Asia, in light of the weakening renminbi and favourable refinancing conditions in domestic markets, provides the sole exception – but even then only with regard to investment-grade rather than high-yield bonds.

The combination of an abrupt rise in demand and a contracting investment environment leads to inflows, which in turn lend themselves to strong technical market dynamics. Together with the attractive fundamentals discussed above, these significantly bolster the appeal of the asset class.

Ratings: reflecting risk and reward

The level of negative-yielding global debt is rising. At present it stands at around US$11.7 trillion, with developed market bonds accounting for the overwhelming majority of this figure.

As a result, provided market conditions remain stable, emerging market bonds offer a more interesting risk-reward proposition than their counterparts in fully industrialised countries. This is particularly so in the case of higher-coupon bonds. Investors who favour emerging market bonds over developed market bonds might expect to receive 80-100 basis points more in yield for investment-grade bonds and around 200 basis points more for high-yield bonds. This is reflected in attractive ratings.

Another edge: risk premium versus debt level

Political risks currently represent arguably the greatest threat to bond markets in emerging economies. Crucially, however, the same can be said for many developed economies.

This being the case, we would argue that this is another reason why emerging market bonds represent a more appealing investment proposition than their counterparts in the US and Europe, as the ratio of risk premium to debt level appears more attractive.

Limiting risk: the growing appeal of short duration bonds

Short-duration bonds are likely to offer an especially sound risk-reward profile for investors who wish to limit risk and volatility. This is as true for emerging markets as it is for anywhere. In tandem, with interest-rate curves flattening over the course of the past year, the traditional appeal of longer-duration bonds is now much less obvious.

In conclusion, the case for investing in emerging market bonds seems stronger now than it has been for at least three years. It is supported by both fundamental and technical analysis and by an attractive risk-reward profile. Following a period in which global investors have been underweight in this asset class, we therefore see real benefit in re-entering the sector at an opportune juncture and with a tailwind driven by ever-growing demand.

About Muzinich

Muzinich & Co is a privately owned, institutionally focused investment firm specialising in public and private corporate credit with over $27 billion of assets under management. The firm was founded in New York in 1988 and also has offices in London, Manchester, Frankfurt, Paris, Zurich, Milan and Madrid. As a corporate credit manager, we offer expertise across the full corporate spectrum including high yield, crossover investment grade, senior loans, and middle market loans. A global perspective prevails through dedicated US, European and Emerging Markets teams.

www.muzinich.cominfo@muzinich.com

Muzinich Emerging Markets Short Duration Fund Facts

Fund Specific Risks:

Credit Risk: Risk that issuers of bonds held in the Fund may default on their obligations or have their credit rating downgraded, possibly resulting in a temporary or permanent decrease in the value of those bonds. Most bonds in this Sub- Fund are rated below investment grade.Liquidity Risk: Risk that the Fund may face difficulties in purchasing or selling its assets, although it endeavours to invest in liquid securities.Interest Rate Risk: Risk that fixed-rate bonds held in the Fund may fall in price with an increase in the prevailing level of interest rates in the economy. This risk usually decreases for bonds of lower rating and shorter duration-to-worst.Currency Risk: Risk that the Fund may invest in multiple currencies or may have investors subscribe in multiple currencies which may fluctuate in value relative to each other. Additionally, the risk that this unit class may be exposed to currencies other than the one in which the unit class is denominated. Although the Manager endeavours to protect the Fund against currency risk, such hedging, achieved through derivative instruments (see "Derivative Risk" below), is at the Manager's discretion and it may not be possible or practical to protect the Fund or individual unit classes against all currency risk.Derivative Risk: Risk that the Fund may use derivative instruments to protect against perceived risks as described under the other headings in this section. Derivative instruments may rise or fall in price or may be subject to risk of non-payment or non-delivery by a counterparty. There is no guarantee that derivatives will provide the anticipated protection. The Fund has not utilized derivatives in the past except to protect against currency risk.Emerging Markets Risk: Risk that Emerging Markets may be more risky than more developed markets for a variety of reasons, including—but not limited to—increased political, social, and economic instability; heightened pricing volatility and reduced market liquidity; potentially small issue sizes; less transparent information standards; heightened currency exposure; reduced legal protections and enforceability; and less developed systems for transaction settlement and custody.Operational Risk: Risk that operational processes, including those relating to the safekeeping of assets, may fail, resulting in losses. Additional information about these and other risks may be found in the prospectus and supplement for the Fund, both of which are available at www.muzinich.com.

Important information:

Past performance is not a guide to future performance. The value of investments and the income from them may fall as well as rise and is not guaranteed and investors may not get back the full amount invested. Where references are made to portfolio guidelines or features, these may be subject to change over time and prevailing market conditions.

Any research in this document has been obtained and may have been acted on by Muzinich for its own purpose. The results of such research are being made available for information purposes and no assurances are made as to their accuracy. Opinions and statements of financial market trends that are based on market conditions constitute our judgment and this judgment may prove to be wrong. The views and opinions expressed should not be construed as an offer to buy or sell or invitation to engage in any investment activity, they are for information purposes only.

The prices of fixed income securities fluctuate in response to perceptions of the issuer’s creditworthiness and also tend to vary inversely with market interest rates. The value of such securities is likely to decline in times of rising interest rates. Conversely, when rates fall, the value of these investments is likely to rise. Typically, the longer the time to maturity the greater are such variations. A Fund investing in fixed income securities will be subject to credit risk (i.e. the risk that an issuer of securities will be unable or unwilling to pay principal and interest when due, or that the value of a security will suffer because investors believe the issuer is less able or willing to pay).

Please note that investment is subject to documentation, including but not limited to the Prospectus and Key Investor Information Document (KIID) which contain a comprehensive disclosure of applicable risks. Investors in the UK should also access the Muzinich Supplemental Information Document (‘SID’). Each of these documents is available in English at www.muzinich.com, together with the Fund’s annual and semi-annual reports. KIIDs are available by share class in each language required in the countries in which the share classes are registered. A complete listing of these KIIDs and the KIIDs themselves are also available at www.muzinich.com. Investors should confer with their independent financial, legal or tax advisors.

In Switzerland - The prospectus (the Switzerland version), the Key Investor Information Documents, the Trust Deed, the annual and semi-annual report in French and further information can be obtained free of charge from the representative of the Fund in Switzerland: Carnegie Fund Services S.A., 11, rue du Général-Dufour, CH-1204 Geneva, Switzerland, web: www.carnegie-fund-services.ch. The Swiss paying agent is: Banque Cantonale de Genève, 17, quai de l'Ile, CH-1204 Geneva, Switzerland. The last unit prices can be found on www.fundinfo.com.

Issued in Europe by Muzinich & Co. Ltd, which is authorised and regulated by the Financial Conduct Authority. Registered in England and Wales No. 3852444. Registered address: 8 Hanover Street, London W1S 1YQ. 2016-08-24-0547