Emerging market corporate bonds produced negative returns in the third quarter as adverse sentiment, poor liquidity, and idiosyncratic developments in Brazil and China weighed on the asset class. China's central bank unexpectedly let its currency devalue, triggering worries about the country's ability to manage a slowdown in growth. Standard & Poor's downgraded its rating on Brazil's sovereign bonds to noninvestment-grade status as the country struggled to implement needed fiscal reforms. The metals and mining and oil and gas sectors experienced the most selling pressure in the emerging market corporate debt asset class as oil and commodity prices declined roughly 25% before stabilizing near quarter-end.
The Emerging Markets Corporate Bond Fund returned −4.25% in the quarter compared with −2.76% for the J.P. Morgan Corporate Emerging Market Bond Index Broad Diversified. For the 12 months ended September 30, 2015, the fund returned −3.78% versus −0.38% for the J.P. Morgan Corporate Emerging Market Bond Index Broad Diversified. The fund's 1-year and Since Inception (05/24/2012) average annual total returns were −3.78% and 3.42%, respectively, as of September 30, 2015. The fund's expense ratio was 1.21% as of its fiscal year ended December 31, 2014.
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The Emerging Markets Corporate Bond Fund charges a 2%
redemption fee on shares held 90 days or less.
The performance information shown does not reflect the deduction of the redemption fee;
if it did, the performance would be lower.
The fund's holdings focus on areas driven by domestic demand, particularly in the consumer, industrials and business services, and real estate sectors. Conversely, many financial sector bonds appear expensive, and the fund is underweight the sector relative to the benchmark. From a regional perspective, we favor bonds issued by companies in countries that are making structural reforms and improving policymaking, including India, Indonesia, and Mexico. From a credit quality perspective, bonds rated BBB and BB appear to offer the most attractive relative value as well as more opportunities to take advantage of pricing inefficiencies. We are relatively defensive within the portfolio's high yield allocation, emphasizing BB rated issuers over those with B or lower ratings.
In the near term, the impending start of a Fed tightening cycle may keep volatility elevated, but that could provide attractive entry points for emerging market corporate debt investors given our expectation for a gradual pace of rate increases. Our long-term outlook for emerging markets corporate debt remains positive, and the asset class should continue to receive support from global investors building their allocations. In addition, the recent downturn has caused a slowdown in new issuance, and the more limited supply should support the prices of existing bonds. A key variable for emerging markets corporate bonds going forward is the slowdown in China, where we expect the government to be able to control the deceleration in economic activity.