TEI: Egyptian Currency Bet Is Interesting, But Hesitant To Recommend Buying

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Midnight Studio/iStock via Getty Images The Templeton Emerging Markets Income Fund (NYSE:TEI) is a closed-end fund, or CEF, that can be purchased by investors who are looking to increase their ...

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I have seen an increasing number of comments from readers who are looking to increase their exposure to emerging markets right now, and there are several good reasons to do so. One of the biggest is that emerging market debt can be one way to protect your money against the erosion of purchasing power that comes with inflation. However, as Claudia Calich at M&G Investments explains:  Adding emerging market bonds to your portfolio can help limit erosion of your assets during inflation. And it allocates capital for new investments at the same time. When you seek to protect your assets against inflation, emerging-market debt is probably not the first asset class to come to mind. It is true that a series of crises in foreign exchange and excessive price rises have marked the history of some countries and left scars on their collective memory. Yet with around twenty-five years’ experience in these markets, including several economic and political cycles, I can attest to the opportunities that this field offers to help protect your assets against inflation.  It can be rather difficult for retail investors to gain access to emerging market debt securities, as most American brokers do not carry an inventory of these securities, or if they do, they will require a huge purchase. It may be difficult to sell a position when and if you manage to get one. The Templeton Emerging Markets Income Fund offers a solution to this problem, as it provides an easy way to obtain exposure to emerging market bonds while retaining liquidity. The fund also boasts a very attractive 10.56% yield at the current price. This is in line with the yield offered by the fund’s peers, although it is not the highest yield obtainable in this sector:   Fund Name Morningstar Classification Current Yield   Templeton Emerging Markets Income Fund Fixed Income-Taxable-Emerging Market Income 10.56%   Morgan Stanley Emerging Markets Debt Fund (MSD) Fixed Income-Taxable-Emerging Market Income 11.29%   Morgan Stanley Emerging Markets Domestic Debt Fund (EDD) Fixed Income-Taxable-Emerging Market Income 7.59%   Virtus Stone Harbor Emerging Markets Income Fund (EDF) Fixed Income-Taxable-Emerging Market Income 12.68%   Western Asset Emerging Markets Debt Fund (EMD) Fixed Income-Taxable-Emerging Market Income 10.61%   Click to enlarge As we can see, three of the four peer funds on the list boast a higher current yield than the Templeton Emerging Markets Income Fund. However, one of these is only five basis points higher, so simple share price movements could erase the yield advantage that the Western Asset Emerging Markets Debt Fund has over this one. After all, yield is dictated by share price, so a decline in the price of the Templeton Emerging Markets Income Fund could swing it to a higher yield. In any case, though, yield-hungry investors might be tempted to invest in a higher-yielding peer rather than the Templeton Emerging Markets Income Fund. However, yield by itself is not everything. After all, outsized yields are frequently a sign that the fund performs poorly or that the market expects that it will have to reduce its distribution. As such, we should take a look at the performance of the Templeton Emerging Markets Income Fund. Here is a five-year chart showing this fund’s performance against its peers along with the J.P. Morgan EMBI Global Core Index (EMB), which tracks the performance of U.S. dollar-denominated emerging market bonds:   Seeking Alpha This certainly is unlikely to win the fund any fans. As we can see, shareholders in the Templeton Emerging Markets Income Fund have seen the value of their shares decline by 46.90% over the past five years. This is the second-worst performance among the funds shown in the chart. The index, in comparison, was only down 19.73%, so this fund obviously declined by much more than the index. However, this was the case for all the emerging market debt closed-end funds, although the Morgan Stanley Emerging Markets Debt Fund only underperformed the index by a few basis points. However, the truth is that investors in closed-end funds like the Templeton Emerging Markets Income Fund typically do much better than the share price suggests. As I explained in a recent article: A simple look at a closed-end fund’s share price performance does not necessarily provide an accurate picture of how investors in the fund did during a given period. This is because these funds tend to pay out all of their net investment profits to the shareholders, rather than relying on the capital appreciation of their share price to provide a return. This is the reason why the yields of these funds tend to be much higher than the yield of index funds or most other market assets. The JPMorgan EMBI Global Core Index has a trailing twelve-month yield of 4.83% so obviously it is much lower than the yield possessed by the Templeton Emerging Markets Income Fund. As the distributions paid out by an asset represent real returns that investors receive, the higher yield paid by this fund will offset the share price losses by a greater extent than the distributions paid by the index. When we take the distributions paid by each of these assets into account, we get the following alternative five-year chart:   Seeking Alpha Unfortunately, this performance still reflects rather poorly on the Templeton Emerging Markets Income Fund. Investors in this fund suffered from a 14.04% loss over the trailing five-year period, even after considering that the distributions offset some of the share price declines. This was the second-worst performance out of the peer group, and it was also worse than the positive 0.37% total return that investors in the index experienced. As was the case when we looked solely at the share price performance, the Morgan Stanley Emerging Markets Debt Fund managed to deliver the highest total return by a significant margin. The fund’s five-year performance history could easily induce potential investors to purchase shares of a peer fund instead of the Templeton Emerging Markets Income Fund. However, it is still important to keep in mind that past performance is no guarantee of future results and today’s underperformer could be tomorrow’s outperformer. Therefore, let us take a look at the Templeton Emerging Markets Income Fund as it is today and see if it makes sense to add it to a portfolio. About The Fund According to the fund’s website, the Templeton Emerging Markets Income Fund has the primary objective of providing its investors with a very high level of current income. This makes sense considering the strategy that the fund employs to achieve its objective. The website does not go into any great detail about its strategy, as it merely states: The fund seeks high current income, with a secondary goal of capital appreciation, by investing under normal market conditions at least 80% of its assets in income-producing securities of sovereign or sovereign-related entities and private sector companies in emerging markets. In this case, the term “income-producing securities” refers strictly to bonds and debt securities. There are some closed-end funds out there that will use this term to refer to dividend-paying common stocks, but this is not one of them. We can see this by looking at the fund’s asset allocation provided by its first-quarter 2024 holdings report. According to this report, the fund’s investment portfolio consisted of the following on March 31, 2024:   Asset Type % of Total Assets   Common Stocks 1.2%   Corporate Bonds 3.8%   Foreign Government and Agency Securities 83.5%   Escrows and Litigation Trusts 0.0%   Egyptian Treasury Bills 8.9%   U.S. Treasury Bills 15.2%   Money Market Fund 2.1%   Click to enlarge This is perhaps the only closed-end fund that I have ever seen that is buying Treasury bills of any country other than the United States. The Egyptian Treasuries appear to be one-year bills, as they all have a maturity date in March 2025:   TEI Q1 2024 Holdings Report This might be an attempt to take advantage of the higher yields offered by these securities compared to U.S. Treasuries. These are local currency bonds, so the interest rate paid by these securities is shown on the current yield curve for Egyptian government securities. Here it is:   Investing.com The current yield of one-year Egyptian Treasury bills is 26.102%. That is obviously far above the yield available from any government security issued by any developed nation. Indeed, that is even far above the current yield available from American junk bonds. As such, the yield is likely to grab the attention of anyone who is starving for yield. However, we should not ignore the currency risk here. The Egyptian pound has dropped 35.24% against the U.S. dollar over the past year, but the exchange rate has been reasonably stable since early March:   XE In fact, we can see that the Egyptian currency has strengthened slightly against the U.S. dollar since March. If the Egyptian pound were to continue to strengthen, that would give the fund a gain from this trade in addition to the very high yield. However, the yield on these bonds is also not enough to offset a 35.24% decline in the currency, so should a similar magnitude decline occur before March 2025 then it will more than wipe out any profit that the fund earns from the high yield on those bills. It appears that management is expecting that the currency will not suffer a similar decline to the one that occurred in early March. The fund’s bet on the Egyptian pound avoiding a similar decline in the next year is probably a pretty safe bet. On March 6, 2024, the Egyptian government announced a deal with the International Monetary Fund to increase its loan amount from $3 billion to $8 billion. It also increased its benchmark interest rate by 600 basis points in an attempt to attract foreign investment. The increased amount from the International Monetary Fund should help to reduce one of the country’s main problems, which has been a shortage of hard currency (according to the International Monetary Fund). Egypt was also suffering from a soaring inflation rate, which the measures announced in early March are intended to correct. The Egyptian currency started floating on March 6, 2024 (it was previously pegged to the U.S. dollar) and as we can see from the chart above, the market has generally been treating the currency pretty well since the measures were implemented. Therefore, at least for now, it appears that we can probably be reasonably confident that there will not be any more major problems before the short-term bills currently held by the Templeton Emerging Markets Income Fund mature. Thus, this could actually end up being a profitable bet by the fund’s management. It is a common practice for closed-end funds that receive income in foreign currencies to use various foreign exchange contracts to hedge their currency exposure. This one is no exception, and the fund’s first-quarter 2024 holdings report lists several foreign exchange contracts:   TEI Q1 2024 Holdings Report The basic purpose of these contracts is to effectively lock in an exchange rate to allow the fund to convert the foreign currency that it receives back into U.S. dollars at a set rate. In the absence of these contracts, the fund could wind up taking big losses because it receives a currency that suddenly depreciates even though its bet that a bond trade would be profitable is correct. Thus, it reduces the currency risk faced by investors in this fund. However, the hedges do not fully cover the entire portfolio. Notably, there are no hedges for the fund’s exposure to the Egyptian pound. Thus, the short-term bet on Egyptian government securities appears to be exactly as discussed. The fund is betting that the currency will not decline again and will profit from the currency trade if the Egyptian pound goes up against the U.S. dollar. I will admit that I am of two minds regarding currency hedges. In various previous articles, I have presented the thesis that the U.S. dollar will decline against the currency issued by some other foreign nations (as well as gold). This is mostly due to the fiscal problems of the U.S. Federal government compared to the more balanced budgets possessed by many emerging market nations. For that thesis, we do not want currency hedges because we want to be holding the foreign currency to get the gains that come from it going up in value against the U.S. dollar. However, at the same time, that is a very long-term thesis. In the short term, the U.S. dollar benefits from the fear trade of rising global geopolitical tensions as well as the currency carry trade as the United States currently has the highest interest rate of any hard currencies. The Templeton Emerging Markets Income Fund also needs a certain amount of income to maintain its distribution and for that, it is necessary to avoid taking on excessive currency risk. Overall, it appears that the Templeton Emerging Markets Income Fund is striking a balance between taking on currency risk when a short-term trade emerges and using hedges to manage its income. This is probably a pretty good strategy given the fund’s goals and the demands of its investors, who desire a certain level of income from the fund. Leverage As is the case with most closed-end funds, the Templeton Emerging Markets Income Fund employs leverage as a method of boosting the effective yield that it earns from the assets in its portfolio. I explained how this works in various previous articles on other closed-end funds. To paraphrase myself:  In short, the fund borrows money and then uses that borrowed money to purchase debt securities issued by entities located in emerging markets around the world. As long as the total return that the fund receives from the purchased asset is higher than the interest rate on the borrowed money, the strategy works pretty well to boost the effective yield of the portfolio. The Templeton Emerging Markets Income Fund is capable of borrowing money at institutional rates, which are considerably lower than retail rates. As such, this will usually be the case. However, the use of debt in this fashion is a double-edged sword. This is because leverage increases both gains and losses. As such, we want to ensure that a fund is not employing too much leverage because that would expose us to an excessive amount of risk. I generally do not like a fund to have leverage exceeding a third as a percentage of its assets for this reason.  As of the time of writing, the Templeton Emerging Markets Income Fund has leveraged assets comprising 15.11% of its total assets. This is obviously well below the one-third of assets levels that we would ordinarily be comfortable with, so that is a positive sign. However, the actual amount of leverage that a fund can reasonably carry is largely dependent on its strategy, so let us see how this fund’s leverage compares with its peers:   Fund Name Leverage Ratio   Templeton Emerging Markets Income Fund 15.11%   Morgan Stanley Emerging Markets Debt Fund 0.00%   Morgan Stanley Emerging Markets Domestic Debt Fund 12.15%   Virtus Stone Harbor Emerging Markets Income Fund 24.70%   Western Asset Emerging Markets Debt Fund 28.86%   Click to enlarge (all figures from CEF Data.) As we can see, the leverage ratio of the Templeton Emerging Markets Income Fund is the median of the five emerging markets debt closed-end funds. This is a good sign, as it suggests that the fund is probably not employing too much leverage for its particular strategy. As such, we most likely do not need to lose too much sleep over this fund’s use of debt. Distribution Analysis The primary objective of the Templeton Emerging Markets Income Fund is to provide its investors with a high level of current income. To that end, the fund pays a monthly distribution of $0.0475 per share ($0.57 per share annually). This gives the fund a 10.56% yield at the current share price. Unfortunately, the fund has not been especially consistent regarding its distributions over the years:   CEF Connect As we can immediately see, the fund has both raised and lowered its distribution numerous times since its inception in September 1993. This situation is likely to be unattractive to those investors who are seeking to earn a safe and consistent income from the assets in their portfolios. However, it is also not especially surprising that the fund would have to vary its distributions because interest rates have a significant impact on the amount of income that can be earned from bonds, and interest rates in many nations generally declined since the 1990s. In addition, emerging market debt generally underperformed domestic bonds over the 2010 to 2020 period:   Seeking Alpha In addition, the JPMorgan EMBI Global Core Index is down since December 2007:   Seeking Alpha As such, the fund almost certainly took some losses and had to reduce its distributions to avoid over-distributing and destroying its net assets. Let us take a look at the fund’s finances to determine how well it can sustain its distribution going forward. As of the time of writing, the most recent financial report available for the Templeton Emerging Markets Income Fund is the annual report that corresponds to the full-year period that ended on December 31, 2023. Therefore, this is the report that we will use for our analysis today. For the full-year period that ended on December 31, 2023, the Templeton Emerging Markets Income Fund received $539,631 in dividends along with $26,163,416 in interest from the assets in its portfolio. This gives the fund a total investment income of $26,703,047 for the period. The fund paid its expenses out of this amount, which left it with $20,533,549 available for shareholders. That was not sufficient to cover the $26,813,808 that the fund paid out in distributions during the period. Fortunately, the fund was able to make up the difference through capital gains. For the full-year period, the fund reported net realized losses of $14,342,920, but these losses were fully offset by $28,671,867 of net unrealized gains. Overall, the fund’s net assets increased by $6,349,387 after accounting for all inflows and outflows during the period. Thus, the fund clearly managed to cover its distributions fully during the period. However, it was only able to do so because of unrealized capital gains, and there is no guarantee that such gains will not be erased in a market correction. However, so far, the fund appears to be okay. This chart shows the fund’s net asset value from December 29, 2023 (the final closing price reflected in the annual report) until today:   Barchart As we can immediately see, the fund’s net asset value has been volatile, but it has generally been positive during most of this year. Overall, the fund’s net asset value today is the same as it was back at the start of the year. This tells us that the fund has managed to fully cover all the distributions that it has paid out so far in 2024, but it has not managed to earn any excess profits. If this trend continues, the fund will fail to cover its distributions. Valuation Shares of the Templeton Emerging Markets Income Fund currently trade at a 9.15% discount to net asset value. This is not quite as good as the 9.72% discount that the shares have averaged over the past month. As such, it might be possible to get a price by waiting for a better entry point. Conclusion In conclusion, the Templeton Emerging Markets Income Fund is one of the few closed-end funds that invests in emerging market debt securities. This is an asset class that probably belongs in the portfolio of any income investor due to the potential for protection against the long-term decline in the value of the U.S. dollar and the fact that emerging market debt securities offer much higher interest rates than domestic fixed-income ones. This is evident in this fund’s high current yield. However, the past performance history gives me pause, particularly since it has significantly underperformed some of its peers in the emerging market debt category.  Due to Templeton Emerging Markets Income Fund’s poor performance relative to its peers, and the fact that the U.S. dollar will probably benefit from the fear trade in the short term, I am hesitant to recommend buying this particular fund today. The fear trade, in particular, could cause it to fail to cover its distribution in 2024.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.24.2","shortVersion":"4.24.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2443084396"}