Active management in action
With income as the anchor for returns, active management and flexibility are key to navigating the volatility and dispersion across the emerging market debt universe.
INTERVIEW
The art of active EMD
Emerging market debt is often misunderstood as a beta-driven asset class, but income has historically done the heavy lifting. In this video, Damien Buchet of Principal Finisterre explains why active management is critical and how its ‘beyond beta’ philosophy uncovers multiple sources of value across a diverse opportunity set.
With a strong emphasis on research-led risk management, the discussion highlights how currency, duration and credit express high-conviction ideas. Buchet also explores demand for income strategies and where the team sees the most attractive opportunities.
Below, we explore these themes in more detail, examining how income shapes portfolios, how diversification works and where active management adds value.
Why do you say emerging market debt is primarily an income asset?
Income is has historically been the anchor for total returns in both EMD hard and local currency markets. Therefore, it always makes sense to maximise the contribution from the coupon stream, which provides far greater visibility on expected outcomes than relying on capital moves. That emphasis naturally leads to shorter-duration positioning, with income portfolios constructed to limit the volatility profile and increase the share of returns delivered through carry. The objective is not to engineer directional calls, but to assemble a highly diversified set of income opportunities that have been carefully vetted from a research standpoint. The question is: can I safely clip my coupons over the next six, 12, or 18 months, without the risk of a meaningful blow-up in that name over that period? The answer to that question is very much the quality of your research and the conviction you can develop around specific stories. If you have conviction in the intrinsic solidity of all the names, your portfolio can withstand a short episode of market wobble without the need to be drastically adjusted.
How does diversification work within the emerging market opportunity set?
Diversification is the defining feature of how we approach the opportunity set. Our income portfolios are typically spread across 40 to 55 countries, but the point is not just breadth-of-country exposure; what happens within each country matters just as much. A position in a single country does not imply a single directional bet. Diversification plays out at an intra-country level through different types of assets that do not necessarily move together. Within a single market, sovereign external debt, local bonds, corporates and currency exposures can all behave differently depending on the underlying trade drivers. Corporate credit can remain resilient over long periods while the currency experiences significant volatility, and sovereign and local market exposures can follow entirely different dynamics. These components do not move in sync. That lack of correlation is central to how income is generated. Diversification is not just about spreading exposure across countries, but about combining multiple sources of return within each country to build a more stable income stream.
‘That is the sweet spot for us – not being overly defensive on duration but allowing a bit more flexibility to deliver more income’
Where does active management add most value within that framework?
By design, our income portfolios are less actively traded. Buy and hold is the default position, reflecting the need to allow coupon income to accrue over time. Active management is less about constant trading and more about how risk is deliberately shaped across the portfolios. Local currency exposure, for example, can be selectively used or hedged depending on the inflation and currency outlook, or during short-term bouts of global ‘flight-to-quality‘ towards the US dollar, allowing the portfolio to retain carry while controlling unwanted volatility Another feature is the active liquidity management. In periods of heightened uncertainty, positions can be trimmed and cash increased temporarily before being redeployed as conditions stabilise. Following the recent Iran-related market shock, cash levels moved from under 5% to 12-15% at the peak, before being gradually reinvested. In practice, that discipline is reflected in low turnover and a preference for holding positions through volatility unless the underlying macro or credit case genuinely changes.
How do you balance carry and volatility when thinking about returns?
By adopting the right filters, we can identify the best carry-to-volatility opportunities for an income approach. In practice, that means we build ‘short duration plus’ portfolios, with a typical duration of around three to four years. The ‘plus’ is typically about a year of additional duration compared to traditional EMD short duration funds, where the extra yield more than compensates for the incremental volatility. Within that framework, 10-30% is typically allocated to local currency high-income opportunities, with the ability to hedge FX risk if we have any concern about currency volatility emerging. The remainder sits in sovereign and credit exposures, driven by our strongest research convictions. The result is a shorter duration approach where the objective is not to maximise return through directional beta, but to extract a higher income stream per unit of volatility. That is the sweet spot for us – not being overly defensive on duration but allowing a bit more flexibility to deliver more income for a modest increase in risk.
‘Our investment decisions are not tied to any index, so we have the luxury to pick our battles as per our own convictions’
How do the Euro Income and High Income strategies differ?
The strategies share the same underlying philosophy of income generation through diversified, short-duration portfolios, but they differ in the level and source of risk being taken.
The Euro Income strategy is positioned more defensively and excludes CCC-rated issuers, targeting a higher-quality credit profile and lower volatility for euro-based investors. Over the past few months we’ve been able to deliver a current yield of around 6.5% from an average rating of BB+. The focus is on maintaining a stable income stream, with an emphasis on limit any credit- or macro-driven drawdown risk through the selection of our highest conviction income opportunities across the sovereign, corporate and local currency debt space.
The EMD High Income strategy takes on a higher level of credit risk (including CCC assets) and is more heavily weighted towards US dollar assets. It typically yields around 7.5-9% in US dollars, with an average rating closer to BB-, reflecting a more aggressive risk budget within the same diversified framework. Both strategies have the same duration philosophy and rely on broad diversification across countries and intra-country asset types. The distinction is not in terms of process, but in the level of risk taken within it, with both ultimately designed to deliver durable income across the cycle.
How do you maintain discipline through volatility in a short-duration income strategy?
The key factor of success in any income strategy is the quality and conviction behind the research. That is what anchors discipline through volatility. Our investment decisions are not tied to any index, so we have the luxury to pick our battles as per our own convictions. That allows us to focus resources where they matter most and adjust the intensity of our research effort to the complexity of each situation. Some positions are relatively straightforward, while others are highly idiosyncratic and require far more conviction. There are many ways to construct portfolios in EM debt, depending on the performance levers you can identify. At any point in time, that flexibility allows us to generate performance.
