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Hartford Schroders Emerging Markets Debt and Currency Fund

November 2017 Monthly Update

Performance (%)
% (as of 12/31/2017)
Average Annual Total Returns % (as of 12/31/2017)
YTD 1YR 3YR 5YR 10YR SI
Hartford Schroders Emerging Markets Debt and Currency  I 7.75 7.75 3.18 1.75 --- 2.11
BENCHMARK 1.10 1.10 0.66 0.50 --- ---
Morningstar Emerging Markets Bond Category 10.14 10.14 4.79 1.19 --- ---
Performance (%)
% (as of 12/31/2017)
Average Annual Total Returns % (as of 12/31/2017)
YTD 1YR 3YR 5YR 10YR SI
Hartford Schroders Emerging Markets Debt and Currency  I 7.75 7.75 3.18 1.75 --- 2.11
BENCHMARK 1.10 1.10 0.66 0.50 --- ---
Morningstar Emerging Markets Bond Category 10.14 10.14 4.79 1.19 --- ---
SI = Since Inception. Fund Inception: 12/15/2011
Operating Expenses:   Net 1.15% |  Gross  1.18%

Performance prior to 10/24/16 for Class I-shares reflects the performance, fees, and expenses of the Investor Class of the predecessor fund Schroder Absolute Return EMD and Currency Fund. If Class I fees and expenses were reflected, performance would have differed. SI performance is calculated from 12/15/11.

Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted.

 

Performance Review

The Fund (Class I Shares) returned 0.76% in November, outperforming its benchmark, the 3-month US Dollar LIBOR, which returned 0.09%. The rebound experienced by emerging markets (EM) currencies and selected local debt markets was a key positive contributor to the Fund’s return during the month. The collapse in Venezuelan bonds and the escalating pressures on Turkish local debt markets had no impact on performance as the Fund continued to avoid these markets. The Fund also maintained its long-standing defensive positioning in EM hard currency debt, as the yields on offer in this sector remain unappealing.

The correction experienced recently by EM currencies and a number of local bond markets appears to have ended in November. For this reason, the Fund started to reinvest the positions that were cut for risk control reasons during the recent period of correction. The positions reinstated were mainly in selected high-yielding local debt markets with a particular focus on Brazil, Mexico, Russia, and South Africa. As a result of this addition of risk, the Fund’s cash balance was reduced from 30% to 18%. Cash will continue to be reinvested in selected local debt markets with the aim to move to a fully invested stance in due course. 

 

Investment Outlook 

EM hard currency debt has already experienced what appears to be an overextended bull market. EM local bonds and currencies have also rebounded strongly from the oversold levels reached in early 2016. The key question for investors is whether these positive trends can persist in 2018.

The tightening in global monetary conditions is the most significant challenge facing EM debt in 2018. The US Federal Reserve has already shown some determination to step up its monetary normalization process and there is a distinct possibility that this may soon turn out to be a late cycle tightening. Our measure of global financial liquidity has already experienced a sharp deceleration this year, which we tend to consider as an early warning indicator that a setback in global financial markets is on the horizon.

This liquidity tightening is exacerbated by the apparent resolve of the Chinese authorities to tackle the unsustainably high level of debt in the nation’s financial system. In this regard, the recent mini cyclical recovery in China appears to have already passed its peak. The delayed impact of the various tightening measures implemented in 2017 and a renewed push for “supply side reforms” could soon reignite concerns about China’s debt dynamics. Chinese policymakers are demonstrating, for now, a strong ability to control the renminbi exchange rate, but we should remain wary of any signs of reescalation in capital flight.

This poor liquidity environment is particularly challenging for EM hard currency debt. We remain of the view that this sector exhibits an unappealing mixture of expensive valuations, heavy positioning by market participants, and increasing illiquidity. 

The average EM external debt yield, as measured by the J.P. Morgan Emerging Markets Bond Index Plus (EMBI+), is currently at 5.8%, of which the defaulting Venezuela alone is contributing 1.2%. In addition, the EMBI+ yield experienced its first leg higher during the taper tantrum of 2013 and has since been in a consolidation range. A potential break higher through the top of this range (6.5%) is needed to confirm a switch from a bull to a bear market for EM hard currency debt.

While EM hard currency debt appears to be priced for perfection, selected local currency debt markets still offer value. We believe that high-yielding local government bonds in countries that have recently undergone macroeconomic adjustments could generate a strong return (in US dollar terms) in 2018 from a combination of yield, bond price gains, and currency appreciation.

To achieve these returns, there will be a particular focus on countries such as Argentina, Brazil, Mexico, Russia, South Africa, India, and Indonesia. These countries still offer relatively high levels of yield, improving external accounts, and, with inflation brought under control, their central banks can continue to withdraw the aggressive monetary tightening implemented during the payments crises of 2013-15.

What we particularly like about these countries is that they have followed what can be described as a predictable and credible trajectory with regards to their recent crisis resolution. We believe that the countries highlighted above are now in a good position to reap the growth benefits of the adjustments they accomplished in the aftermath of their payments crises. The “adjustment phase” of the cycle is well advanced and there is already tentative evidence that these countries are moving into the “equilibrium phase.

For this reason, we believe that the recovery in a number of EM currencies that appears to have started in early 2016 is still in its early stages. The improvements in trade balances that these EM are still experiencing and the relatively attractive level of their real effective exchange rates bode well for further currency strength in 2018.

While the economic cycle in our favored EM is in its positive phase, the same could not be said about their political cycles. Brazil and Mexico will be facing presidential elections during the second half of 2018. South Africa is currently experiencing a volatile transition as the governing African National Congress Party is deciding who will succeed Jacob Zuma, the current controversial president. Politicians in Indonesia and India will also soon start the maneuverings ahead of the general elections scheduled to take place in both countries in 2019.

These potential political tensions could create volatility in the next 12 months, which will need to be managed by scaling back exposures when required. However, our favored EM are now better equipped to withstand these political uncertainties, especially given the adjustments and the improvements in growth prospects highlighted above. We also remain of the view that the electorates in these countries could reward leaders with good reform credentials. This has already been illustrated in Argentina, where President Macri has won the recent mid-term elections, thus reinforcing his ability to pursue his reform agenda. 

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Quarterly Fund Outlook & Commentary
US Alternatives Director Eric Nelson

 

Important Risks: All investments are subject to risk, including the possible loss of principal. There is no guarantee the Fund will achieve its stated objective. The Fund’s share price may fluctuate due to market risk and/or security selections that may underperform the market or relevant benchmarks. Fixed Income risks include credit, liquidity, call, duration, and interest-rate risk. As interest rates rise, bond prices generally fall; these risks are currently heightened because interest rates are at, or near, historical lows. Obligations of U.S. Government agencies are supported by varying degrees of credit but are generally not backed by the full faith and credit of the U.S. Government. Investments in high-yield (“junk”) bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. Derivatives may be riskier or more volatile than other types of investments because they are generally more sensitive to changes in market or economic conditions; risks include currency, leverage, liquidity, index, pricing, and counterparty risk. Foreign investments can be riskier and more volatile than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as political and economic developments in foreign countries and regions (e.g., “Brexit”). These risks are generally greater for investments in emerging markets. The Fund may have high portfolio turnover, which could increase the Fund’s transaction costs and an investor’s tax liability. The Fund is non-diversified, so it may be more exposed to the risks associated with individual issuers than a diversified fund. The Fund may be adversely affected when certain large shareholders purchase or redeem large amounts of shares of the Fund.

The views expressed herein are those of Schroder Investment Management North America Inc. (Schroders) are for informational purposes only, and are subject to change based on prevailing market, economic, and other conditions. They may not reflect the views of Hartford Funds or any other sub-adviser to our funds and should not be construed as research or investment advice or as an offer or solicitation to buy or sell any security.

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