Franfurt, 1 November 2010

Investors have largely failed to recognize the changing face of emerging markets and the potential of fundamentally undervalued currencies, especially in Asian and African countries, a UBS fund manager told Reuters last week.

"Over the past five to 10 years emerging markets have reduced their credit risk, improved their debt dynamic and many have stabilized politically without the majority of investors realising it," Uta Fehm said.

"Countries with a strong exposure to commodities will see currencies gaining strength significantly over the next couple of years, especially in Nigeria, Ghana and parts of Southeast Asia," she added.

Fehm manages the $1.6 billion UBS Emerging Economies Global Bonds fund as well as its sub-fund, the $390 million Emerging Economies Global Short Term Fund. She believes that investors are still grossly underinvested in emerging markets and that the risk of a potential emerging markets bubble bursting are therefore minimal.

"Central banks in emerging markets are still very careful in terms of base rates and controlling inflation," she said. "Bond spreads have narrowed considerably and are likely to remain narrow so I don't see the risk of a bubble," she added.

Top 10 holdings in the Global Bonds fund, which invests principally in U.S. dollar-denominated bonds and securities in the local currencies of emerging economies, include Brazil, Russia, Indonesia and Turkey.

It has outperformed its customised benchmark -- made up by 50 percent of the JP Morgan Emerging Markets BIG index and by 50 percent of the JP Morgan GBI-Emerging markets Global diversified index -- by 0.76 percent year to date.

Although China is a strong player with huge growth potential, Fehm said that -- due to its sheer size -- it often casts a shadow over its smaller peers, like Indonesia.

"Indonesia could legitimately take over from India in becoming the "I" in the BRIC acronym," Fehm jokes, citing the nations stabilising politics and economic fundamentals driving strong off-shore demand.

The yield on 10-year Indonesian government bonds has fallen 275 basis points this year to 7.25 percent on Tuesday. Indonesia expects gross bond issuance of 210.6 trillion rupiah next year to plug a budget deficit of 1.8 percent of GDP or 124.7 trillion rupiah, according to the 2011 state budget approved on Tuesday.

"Nonetheless," Fehm said, "we must remember that if China sneezes, countries like Indonesia and Malaysia will get a cold. That's how dependent they are." She is adamant, however, that risk should not be exaggerated.

"In developed nations, national debt has been reaching an average of more than 100 percent of gross domestic product this year. Debt in emerging markets will remain constant at about 40 to 50 percent of GDP," Fehm said.

"Now it's just a question of convincing investors that emerging markets really do offer a strong, limited-risk investment case."

Ends --

By Josie Cox, Reuters - for Commodities Now