Hancock Finds More Value In Emerging Markets


With emerging markets debt improving and the junk market still lagging, crossover buying overseas is starting to make its appearance, as Arthur Calavritinos, vice president and portfolio manager at the $1.1 billion John Hancock High Yield Bond Fund, has shown.

Contrary to many of his U.S high yield investor counterparts, Calavritinos is more bullish on his overseas investments, and has a particular penchant for corporate issues in the emerging markets. "I don't see U.S. companies that have the power of the emerging markets," Calavritinos said.

Indeed, of the 19% his portfolio allocated to foreign corporate bonds, about 8.5% is devoted to emerging markets corporate debt, he said. And this is likely to increase even further going forward, to as much as 12% in the near term.

Calavritinos' approach is sectoral and industry specific. He is particularly keen on the pulp and paper sector, he said, an area in which many Asian companies have the upper hand. Lower-cost Asian companies, such as Indonesia's Asia Pulp and Paper - a favorite among many dedicated emerging markets players - which are able to produce paper at low cost in local currency, and receive revenues in dollars or other hard currencies, have seen an upside in recent months, Calavritinos said. That upside has been further enhanced by the upswing in Asian economies.

The Asian pulp and paper issuers are in turn helping his U.S. paper investments by forcing the domestic companies to keep capacity at current levels. Some of the domestic high yield issuers' debt has already seen upside beyond 20 points, but the outlook going forward is even better, he said, due to the slowdown in new capacity in the U.S. combined with the Asian comeback.

As yet, Calavritinos has not bought any emerging market sovereign issues. However, he is looking at them, he said, and may consider adding them to his portfolio down the road, should they offer comparable value to emerging markets corporates.

The financial turmoil that hit Asia and the rest of the emerging markets from 1997 through most of 1999, albeit devastating to the global economy, did nonetheless provide some great opportunities for investors interested in scooping up yield at rock-bottom prices, he said. Many high yield investors, though, who remained focused on the U.S., did not choose to take advantage of this spread widening.

They might have fared well if they had, given the state of the high yield market in the U.S. One of the main problems facing high yield investors is the general lack of good credits, Calavritinos said. "What I see is a whole lot of [unappealing] companies," he said. "A lot of high yield companies that have come are just bad businesses."

Cyclicals Poised To See Some Upside

When it comes to the domestic issuers, he likes the cyclicals at the moment. The recent growth in the economy that largely has resulted without a corresponding increase in interest rates is owed to technology, he said. But he doesn't expect that scenario to last, and he views the inflation-sensitive issuers as one area that is likely to see price increases.

U.S. issuers that he used to hold in his portfolio mix, such as Phillips Petroleum and United Airlines, are now in the investment-grade arena, and there are not as many good high yield names to take their place, he said.

And some of the names that were considered safe plays when they priced - Fruit of the Loom and Just For Feet, for example - have tanked in the past few months. In fact, Just For Feet just last week announced it would file for bankruptcy protection and its 11% notes of '09 fell to nine cents on the dollar in the secondary market.

The top 10 holdings of the fund are: Northwest Airlines, which has 2.8% of the assets; Key Energy Group's convertible issue, which has 2.0%; Nextel Communications, at 1.9%; Repap New Brunswick, 1.5%; P&L Coal Holdings, 1.4%; Abitibi Consolidated, 1.34%; Key Energy's preferred stock issue, 1.32%; Gaylord Container, 1.31%; Stone Container, 1.19%; and Viatel, 1.15%.

The emerging markets, on the other hand, offer great potential at present. Besides his interest in Asia, Calavritinos also is interested in Europe, developed as well as emerging.

European issuers have some tremendous upside potential, he said, and their debt offers the potential for great gains. The telecommunications industry, in particular, is an easier game in Europe than in the U.S., he said, as there is less competition in the former.

In addition to telecom plays, there will be some attractive industrial issuers tapping the market in Europe, as big conglomerates begin to divest parts of their businesses, he said.

His big concern about telecom, both in the U.S. and abroad, however, is the sheer amount of capacity that's being built and whether there will really be enough demand to fill it.

"You can't repeal the law of supply and demand," he said. And as evidence of that, he noted that few market experts in the early 1980s were questioning that oil would be as much as $100 a barrel. Today, it's in the $20 range.

Down the road, he said he might change his mind and consider the telecommunications sector as one with more value. And when that happens, he'll certainly change his investment mix to reflect that. He doesn't buy oil and paper debt because he inherently likes those industries; rather, he simply views them as the value industries right now and for the foreseeable future.

"We have the wind at our back for the next year plus," he said.