TEI fund statement
Templeton Emerging Markets Income Fund (NYSE:TEI) is a closed-end fixed income fund focused on emerging markets. It has a mandate to invest at least 80% of its net assets in income-producing securities of sovereign and private entities. sector companies in emerging market countries. In terms of corporate bonds, it currently has a share of less than 5%. More than 90% of net assets consist of government and foreign agency securities.
I’m the first covered TEI last year due to the observation that EM bonds looked cheap from a long-term historical perspective. While I believed the asset class could offer some good dips to buy in 2023, I wasn’t convinced that TEI was a good fund to use.
How TEI worked in 2023
At the time the discount to NAV was only a modest 7%, so there was one reasonable risk this may expand further during the year. This actually happened, with the discount down to 14% by the end of last year. This meant that total returns based on market price were not that good during this time.
However, TEI performed well in 2023 if we judge in NAV terms. After a bumpy ride, they achieved a total return of 14% compared to their benchmark which returned 10.5%. His positioning for USD weakness eventually paid off later in the year. I see risks however to USD strength in the first half of 2024, which would hurt TEI.
With EM bonds having had a solid bounce from October lows and other similar funds to choose from, it’s time to revisit whether TEI is worth holding.
TEI fund facts
Below are the current fund details updated to 31 December 2023. To achieve the high yield below, they have more than half of the portfolio in below investment grade or unrated bonds. They have also been willing to shift currency and duration exposures very actively in the past.
At the time of writing, TEI is trading at roughly a 10% discount to its NAV. While in some other cases of CEFs such a discount may be attractive, this is not one of them. TEI’s assets have halved in about the last 5 years, with the fund’s expense ratio rising from 1.2% to 1.4% now.
TEI’s past funding performance
In further justification of why a 10% discount to NAV for TEI is not particularly attractive, the past 5 years have underperformed the benchmark. While this has been a difficult period for the sector (the benchmark returning just 2% p.a. reported annually), TEI’s returns have trailed by more than 3.5% p.a. each year.
Right off the bat, the performance numbers haven’t looked too bad, but I’m still hesitant to put too much weight on it. The two portfolio managers listed in the TEI website are shown to have managed the fund since 2006 and 2018. The performance figures since inception are flattering due to the period before the fund was administered by the current prime minister.
Peer analysis of TEI funds
If we focus more on the period where the two prime ministers have jointly managed the fund since around 2018, it does not read well against colleagues.
Alternative CEFs focused on EM debt such as MS Emerging Markets Debt Fund (MSD) and Western Asset Emerging Markets Debt Fund (EMD) have better long-term performance records. Interestingly though, these two alternatives have also tended to trade around 10% off their mark NAV over the past few years, like TEI.
Since I last reviewed TEI here about 1 year ago, the relative performance has deteriorated.
Time to cut the poor performers after almost everything is collected
The charts above for the past year show a noticeable bump in the fourth quarter for emerging market bond funds. As TEI’s performance history remains disappointing, it’s worth revisiting in early 2024 if it’s worth holding.
The past few months in the markets can be described as a “rise of almost everything”, where it is easy to become complacent with our portfolios.
In the fourth quarter of last year, in addition to commodities being weak, it was hard not to have big returns in other asset classes.
A rising tide lifts all boats and TEI has performed well ever since. Before that, at the end of the third quarter, TEI was trading at a discount to NAV of around 15%.
Now the discount is more than 10%, but some things have not changed. The facts are that TEI has underperformed in the long term, is downsizing and cost ratios are increasing.
At the same time, I see rising risks of USD strength posing near-term risks for TEI. A scenario where markets overvalue US rate cuts that have been factored in could lead to a reversal of Q4 2023 trends.
TEI expects USD decline in 2024, what are the risks?
When looking at the various EM debt funds, it is important to note whether they tend to stick to USD debt securities or not.
Other CEFs I’ve used as a comparison before, like MSD & EMD, focus primarily on USD denominated debt and thus minimize currency risk.
TEI on the other hand sees investing in local currency debt in emerging markets as a potential additional source of alpha. Going into 2024, according to TEI Commentary December 2023 available here, they saw emerging market sovereign debt in local currencies as more attractive. To quote from their December report, “Our main local currency exposures include India, Colombia, Malaysia, Brazil and Thailand.”
Below are active TEI currency bets as of December 31, 2023.
However, history has shown that TEI’s different approach to currency risk-taking does not seem to be helping it grow returns.
In my opinion, the coming months could present risks for those investors who are betting heavily on USD weakness. The latest US jobs data has surprised on the strong side, and The Fed is taking it slow with possible rate cuts, but markets want more. Such a backdrop provides further scope for USD strength in the coming months.
In terms of duration, they are also willing to take big bets at certain times. The latest duration reported on TEI’s website showed them at 6 years versus the standard duration of 6.9 years. However, when I reviewed TEI a year ago, the duration was only 3.3 years. They also use some leverage in the fund.
There are better alternatives to TEI
With the currency’s outlook uncertain in the short term and TEI’s poor long-term performance, it makes sense to consider alternatives.
Just last month, I reviewed MS Emerging Markets Debt Fund, which I considered to be a better choice for those looking to gain exposure to EM bonds. MSD does not take the large active underweight in USD that TEI does and has been the best performer among peers. While EMD was competitive in these performance comparisons, it still trailed MSD despite showing more volatility. EMD generally assumes more risk for similar returns to MSD, often through leverage and greater exposure to corporate debt.
The long-term outlook for emerging market debt is favorable
I am still relatively positive long-term on EM bonds as an asset class. Despite yields falling sharply during the fourth quarter of last year, they are still considered high in terms of the past two decades.
However, similar to a year ago, EM debt has made some very strong returns, bottoming out in October and rising through February. As in February last year, the asset class faces heightened short-term risks in the coming months after such a sharp bounce in returns.
In this context, I see it as an opportune time to exit TEI. For those looking for EM debt exposure for the long term, buying MSD on future dips may make better sense.
TEI distribution history
You get a high annual yield with TEI and you get paid every month. However, for the last decade fundamental returns have been negative, so you’re just getting your capital back. During this time, the size of the fund has decreased dramatically, and the expense ratio has increased.
TEI Funds for geographic and credit rating divisions
Discount of TEI funds to NAV
The discount to NAV for TEI is currently around 11%, not much different from the average of the last 5 years.
TEI is a perennial underperformer, so the current sharp rise in returns in recent months is an opportune time for holders to reassess their position.
The months ahead look quite uncertain as to what the Fed might do. In that environment, it’s best to avoid a fund like TEI. That is, a fund that likes to take big active bets on duration and currencies, but has not shown success in doing so.
Longer term, EM debt still has appeal as an asset class, however, better alternatives to TEI are available for such exposure.