HY Market Influences Emerging Market Fund

For Mark Smith, manager of J.P. Morgan's $10 billion Global Extended Markets portfolio, emerging markets debt has become quite attractive.

In the past couple of months, bonds have rallied significantly, he said, as a result of reduced risk to the sector. And his fund's 19% allocation to the asset class has yielded substantial returns.

While Smith's decision to increase his emerging markets allocations will depend on opportunities presented by individual countries, it also will be contingent upon the potential for future returns in other asset classes, particularly high yield.

High yield bonds now account for 23% of his portfolio, while private mortgages accounts for 33%; private corporate bonds, 15%; and developed country debt, 10%.

The asset class most likely to experience a rally is high yield debt, he said. In the new year, his fund will be looking at the opportunities offered by the asset class both in the U.S. and in Europe.

"We look for the establishment of value in that sector which will likely lead to future returns," Smith said. "We seek to make our investments prior to the realization of strong performance from any given sector. We don't chase yesterday's performance but rather position our portfolio to take advantage of tomorrow's performance opportunities."

Still, emerging markets have undeniably experienced a positive run in the past couple of months, even outperforming high yield debt, Smith said.

On average, the Global Extended Markets Fund has had about 15% of its assets under management allocated to emerging markets debt, and this is the long-term average Smith hopes to achieve again going forward.

The fund was launched in 1995 to meet the growing demand of large U.S. institutional investors, such as pension funds, for more diversified, riskier investment vehicles, Smith said. Mixed products like the Global Extended Markets Fund offer greater opportunities for reward than core, dedicated products, he said.

However, the nature of emerging markets debt is such that it is not without risk, Smith said. Indeed, the asset class is always going to be subject to volatility, he said, which is why he does not have a set plan to increase the Global Extended Markets' current exposure to emerging markets fixed income in the initial part of the new year.

Although the financial crisis that ravaged the global economy for close to two years might have abated, many countries are still dealing with its legacy. A number of emerging markets sovereigns are still highly dependent on the growth rate of the global economy, Smith said, a fact that might cause them problems in 2000, should growth in the U.S. or other industrialized nations slow down as some economists have predicted it will.

Furthermore, the commitment some emerging market sovereigns have made to policy continuity, their currency regimes in particular, is also an issue of some concern, he said.

Yet Smith and his team will be keeping their eyes open in 2000 for opportunities in emerging markets debt that will capture greater returns for their portfolio while simultaneously steering clear of market risk. The team does not expect any significant slowing down in global economic growth, Smith said. The "playing field" that is emerging markets debt is vast, and it is no problem to find investment opportunities for which " we have stronger conviction and less expected volatility," he said.

Currently, the Global Extended Markets portfolio is most heavily invested in the sovereign debt of Latin America, particularly the bonds of Mexico and Brazil.

"As we look at Latin America, we see global growth as being a strong support for that region," Smith said. "Mexico and Brazil are ideally supported by that growth."