Emerging Markets Bonds

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Topic Author
Erwin
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Emerging Markets Bonds

Post by Erwin »

Dear All,
I have been investing for a few years about 5% of my portfolio (IRA account) in emerging markets bonds through Fidelity New Markets (FNMIX). Up to early 2013, the fund was rather successful, but since then it has lost about 7%. I do intend to keep the money in bonds but I wonder if it would not be a good idea to switch the funds to the Total US bond Market hoping to slowdown the potential continued drop. The emerging market sector seems to be struggling already for a while. Does it make sense?
Erwin
Valuethinker
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Re: Emerging Markets Bonds

Post by Valuethinker »

mpt follower wrote:Dear All,
I have been investing for a few years about 5% of my portfolio (IRA account) in emerging markets bonds through Fidelity New Markets (FNMIX). Up to early 2013, the fund was rather successful, but since then it has lost about 7%. I do intend to keep the money in bonds but I wonder if it would not be a good idea to switch the funds to the Total US bond Market hoping to slowdown the potential continued drop. The emerging market sector seems to be struggling already for a while. Does it make sense?
Boglehead Opinion

Having set your IPS and asset allocation, you stick to it. It's time to rebalance into EM bonds. What you are doing here is market timing, and that never works, long run.

Non Boglehead Opinion

You didn't understand the risks of EM bond investing. That EMs go through these periodic crises, and they are correlated with each other-- countries go down like a row of dominos. You shouldn't have invested in EM bonds-- bonds are for safety.

[EDIT see exchange below. Apologies if the above is rude. I was trying to highlight the dangers of investing in things whose risk we don't really understand. EM Bonds have volatilities which can approach those of stock investing (developed country stocks) and developed country stocks are bad enough)]

I don't think this EM bond ruckus is over. Based on past experiences, it will go down some more. I'd sell and go into TBM or US Treasury bonds, and not dabble in this area again. If you want EM exposure, take it in stocks. They will be even more volatile, but offer higher upside.

[EDIT. If not clear, this is the old risk-return argument. EM stocks are even more volatile than EM bonds. But you do at least have the potential for very great upside-- some EM markets will some day 'emerge' and become developed markets]
Last edited by Valuethinker on Thu Feb 06, 2014 6:24 am, edited 1 time in total.
Topic Author
Erwin
Posts: 1929
Joined: Fri Apr 27, 2007 11:16 pm

Re: Emerging Markets Bonds

Post by Erwin »

ValueThinker,

I appreciate your input; although if I were you I would shy away from making comments that someone does not understand something, like you stated in your respond, without really knowing that person and the reasons for his/her actions. You would be surprised how far your comments, which in general I find very good having read you for a while, can impact without commenting on the capabilities of the individual asking the question.
Anyway, food for thought, and thank you again for your input.
Erwin
Valuethinker
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Re: Emerging Markets Bonds

Post by Valuethinker »

mpt follower wrote:ValueThinker,

I appreciate your input; although if I were you I would shy away from making comments that someone does not understand something, like you stated in your respond, without really knowing that person and the reasons for his/her actions. You would be surprised how far your comments, which in general I find very good having read you for a while, can impact without commenting on the capabilities of the individual asking the question.
Anyway, food for thought, and thank you again for your input.
Erwin, point taken. I apologize that I was rude.

I was careful in that I said 'you didn't' -- ie I was trying to suggest you were ill informed when you actually made the original investment decision.

As you can see I have schizophrenic views about this-- there's a Boglehead me, and a somewhat non-kosher me who thinks about valuation and gives opinions are same (and we hold here as a truth that such opinions are essentially worthless).

I confess a certain exasperation sometimes, and probably channeled that at you. One can state again and again about some of the risks of investments, and people just don't believe you until it pops up. Those of us who do this on this Forum are not usually talking out of thin air. I *remember* the Mexico Crash (1984 and then 1994). And I remember what happened to EM during those time periods. The whole enthusiasm for EM is actually quite recent.

I believe I said in a number of threads that the EM bond thing was probably done, that the opportunity was in so called 'local' bonds, ie that don't pay in USD but in the local currencies. Poster Stratton pointed out that there were few funds that do this. In any case, that strategy has probably turned into a very risky strategy in the last few months.

Oddly enough someone asked me about all this in the pub last night (as you do ;-)). What I remember about these EM setbacks is they go a lot further than you think they will, or should-- it turns into a panicked rout. Countries get hit that were fairly well managed, but the bulldozer of contracting liquidity crushes them too.

I mean it's really no surprise that Argentina is in a total mess. It's the poster child of how not to run a macroeconomy (Paul Krugman said as much in blog post this week). But *that* spooks investors in other EM? India, by contrast, somewhat to my surprise, has stopped the rout-- Rajan has done good work as Central Bank governor. But India has some really quite serious structural issues and one man cannot alone change that.

The thing with EM bonds, which is not true of developed market government bonds (someone will yell 'Greece' at this point) is that there is real credit risk in them. The countries borrow in USD, and if they have a crisis their own currency plummets and they struggle to service their debts. Cue restructuring. So we have to ask ourselves as investors 'is the upside on bonds so good for me that I want to deal with credit risk?' And since we are not professional institutional investors I have to say most of us should not do this.

The argument is 'this time it's different'. Compared to 1998 the countries have flexible exchange rates, large foreign exchange reserves. The real killer, that domestic companies borrowed in foreign currency and now cannot repay, is much less of a factor. And yet. And yet. 'this time it's different' are some of the most dangerous words in finance.

With EM stocks you do have the compensation that there are good companies in bad countries, and some day the stocks may rise above the level at which you invested them (I remember after 1994, for some Mexican and other stocks, this took something like 10 years).

I think it's a general thing here that we rail against investing in things we don't understand. Or at least not so much it hurts when it goes really wrong. *I* don't understand, or don't have any forecasting ability on, what happens with EM governments and their debts. The risks, to me, don't justify the returns.

I get what a gilt or a Treasury Bond is- an 100% solid promise by the UK or US government to pay interest and repay. Even in wartime that was true (although inflation is a threat). I get what a US stock or a global stock index fund is-- proportionate share in the profits and dividends of the world's listed companies.

Once we go beyond that in investing, it gets hard. I *think* TIAA RE is a good fund, and I understand what it is doing. Is it better than a REIT index fund? I don't know, I just think so. The difference is probably not large in the long run. Do we need REITs at all? After 2008 I thought the volatility suggested maybe not. Gold? I've got no clue. Looks like hocus-pocus to me.

My own experience of 'esoteric' investing (the UK had massive tax incentives to invest in venture capital funds that are listed) has been pretty unhappy.

Once again my apologies for being rude or aggressive.
lazyday
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Re: Emerging Markets Bonds

Post by lazyday »

mpt follower wrote:but I wonder if it would not be a good idea to switch the funds to the Total US bond Market hoping to slowdown the potential continued drop
VT might be saying, in part, that large drops should have been expected when purchasing the fund. If you did expect such risks, then did you expect to attempt to sell early in the drop? This gets to the market timing issue, discussed in length on the forum.
lazyday
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Re: Emerging Markets Bonds

Post by lazyday »

Valuethinker wrote:The argument is 'this time it's different'. Compared to 1998 the countries have flexible exchange rates, large foreign exchange reserves. The real killer, that domestic companies borrowed in foreign currency and now cannot repay, is much less of a factor.
I take it you read the Economist article partly on EM reserves, current account, etc. If not I can link it.

I've heard a claim that some coutries that found discipline some years ago are going back to old habits.
I think it's a general thing here that we rail against investing in things we don't understand.
Maybe you've seen the damodaran blog posts on trying to value under great uncertainty. I can provide search terms or links here too. One of the posts was on valuing twitter before the IPO.

I agree on (among other things) EM equity at least has a big potential upside. GMO has somewhat rosy predicted expected returns for EM debt, but I wouldn't touch it at twice today's real yield or for US$ demonimated, spread vs developed.
jimkinny
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Re: Emerging Markets Bonds

Post by jimkinny »

TBM fund has gone down somewhere in the range of 4-5% since last may/june, whenever the date was that Bernake convinced the world that QE would be coming to an end. There was a bit of recovery but still, EM and developed market debt took a bit of a hit.

So, you would have lost a bit anyway. Even so, 7% of a 5% slice of a portfolio is not much, less than a 1% drop due to EM debt but right now, every thing seems to be going down, except for Treasuries. So, are bonds for safety only, in your opinion, or maybe some yield also?

I have never read any academic derived/based study that advocated EM debt. Maybe Vanguard has some data, I do not know and only recall reading the paper that showed a very marginal benefit of international debt, not EM debt, but maybe the data is out there, indicating that EM debt in a portfolio is beneficial.

I would revisit my reasoning for buying it in the first place and if you think it is still a good reason, stay the course and consider it is a very small portion of your portfolio.

All of this EM currency stuff may pass without it getting worse, maybe not.

jim
Topic Author
Erwin
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Joined: Fri Apr 27, 2007 11:16 pm

Re: Emerging Markets Bonds

Post by Erwin »

Valuethinker wrote:
mpt follower wrote:ValueThinker,

I appreciate your input; although if I were you I would shy away from making comments that someone does not understand something, like you stated in your respond, without really knowing that person and the reasons for his/her actions. You would be surprised how far your comments, which in general I find very good having read you for a while, can impact without commenting on the capabilities of the individual asking the question.
Anyway, food for thought, and thank you again for your input.
Erwin, point taken. I apologize that I was rude.

I was careful in that I said 'you didn't' -- ie I was trying to suggest you were ill informed when you actually made the original investment decision.

As you can see I have schizophrenic views about this-- there's a Boglehead me, and a somewhat non-kosher me who thinks about valuation and gives opinions are same (and we hold here as a truth that such opinions are essentially worthless).

I confess a certain exasperation sometimes, and probably channeled that at you. One can state again and again about some of the risks of investments, and people just don't believe you until it pops up. Those of us who do this on this Forum are not usually talking out of thin air. I *remember* the Mexico Crash (1984 and then 1994). And I remember what happened to EM during those time periods. The whole enthusiasm for EM is actually quite recent.

I believe I said in a number of threads that the EM bond thing was probably done, that the opportunity was in so called 'local' bonds, ie that don't pay in USD but in the local currencies. Poster Stratton pointed out that there were few funds that do this. In any case, that strategy has probably turned into a very risky strategy in the last few months.

Oddly enough someone asked me about all this in the pub last night (as you do ;-)). What I remember about these EM setbacks is they go a lot further than you think they will, or should-- it turns into a panicked rout. Countries get hit that were fairly well managed, but the bulldozer of contracting liquidity crushes them too.

I mean it's really no surprise that Argentina is in a total mess. It's the poster child of how not to run a macroeconomy (Paul Krugman said as much in blog post this week). But *that* spooks investors in other EM? India, by contrast, somewhat to my surprise, has stopped the rout-- Rajan has done good work as Central Bank governor. But India has some really quite serious structural issues and one man cannot alone change that.

The thing with EM bonds, which is not true of developed market government bonds (someone will yell 'Greece' at this point) is that there is real credit risk in them. The countries borrow in USD, and if they have a crisis their own currency plummets and they struggle to service their debts. Cue restructuring. So we have to ask ourselves as investors 'is the upside on bonds so good for me that I want to deal with credit risk?' And since we are not professional institutional investors I have to say most of us should not do this.

The argument is 'this time it's different'. Compared to 1998 the countries have flexible exchange rates, large foreign exchange reserves. The real killer, that domestic companies borrowed in foreign currency and now cannot repay, is much less of a factor. And yet. And yet. 'this time it's different' are some of the most dangerous words in finance.

With EM stocks you do have the compensation that there are good companies in bad countries, and some day the stocks may rise above the level at which you invested them (I remember after 1994, for some Mexican and other stocks, this took something like 10 years).

I think it's a general thing here that we rail against investing in things we don't understand. Or at least not so much it hurts when it goes really wrong. *I* don't understand, or don't have any forecasting ability on, what happens with EM governments and their debts. The risks, to me, don't justify the returns.

I get what a gilt or a Treasury Bond is- an 100% solid promise by the UK or US government to pay interest and repay. Even in wartime that was true (although inflation is a threat). I get what a US stock or a global stock index fund is-- proportionate share in the profits and dividends of the world's listed companies.

Once we go beyond that in investing, it gets hard. I *think* TIAA RE is a good fund, and I understand what it is doing. Is it better than a REIT index fund? I don't know, I just think so. The difference is probably not large in the long run. Do we need REITs at all? After 2008 I thought the volatility suggested maybe not. Gold? I've got no clue. Looks like hocus-pocus to me.

My own experience of 'esoteric' investing (the UK had massive tax incentives to invest in venture capital funds that are listed) has been pretty unhappy.

Once again my apologies for being rude or aggressive.
Good points!
Erwin
Valuethinker
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Re: Emerging Markets Bonds

Post by Valuethinker »

jimkinny wrote:So, are bonds for safety only, in your opinion, or maybe some yield also?
You want interest rate risk from your bonds, not other types of risk. Interest rate risk means yield.
I have never read any academic derived/based study that advocated EM debt. Maybe Vanguard has some data, I do not know and only recall reading the paper that showed a very marginal benefit of international debt, not EM debt, but maybe the data is out there, indicating that EM debt in a portfolio is beneficial.

I would revisit my reasoning for buying it in the first place and if you think it is still a good reason, stay the course and consider it is a very small portion of your portfolio.

All of this EM currency stuff may pass without it getting worse, maybe not.

jim
i am sure that you could show that there is some fractional movement towards the efficient frontier by investing in EM debt.

But didn't most people just invest in it because it was paying a higher yield? Without considering the additional sources of risk? ie the systemic disruptions that Emerging Markets undergo from time to time, reflected in the yield spreads over US Treasuries.

At one time Brasil and Indonesia were trading at 1000 basis point premia. Then they were trading at 150 bps. At which point in time did the market have the correct view?

Do you really want to speculate on shifting credit risk premia of Emerging Markets?
Valuethinker
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Re: Emerging Markets Bonds

Post by Valuethinker »

lazyday wrote:
Valuethinker wrote:The argument is 'this time it's different'. Compared to 1998 the countries have flexible exchange rates, large foreign exchange reserves. The real killer, that domestic companies borrowed in foreign currency and now cannot repay, is much less of a factor.
I take it you read the Economist article partly on EM reserves, current account, etc. If not I can link it.

I've heard a claim that some coutries that found discipline some years ago are going back to old habits.
I think it's a general thing here that we rail against investing in things we don't understand.
Maybe you've seen the damodaran blog posts on trying to value under great uncertainty. I can provide search terms or links here too. One of the posts was on valuing twitter before the IPO.

I agree on (among other things) EM equity at least has a big potential upside. GMO has somewhat rosy predicted expected returns for EM debt, but I wouldn't touch it at twice today's real yield or for US$ demonimated, spread vs developed.
Thank you I shall look up Economist article (i am sure I have it somewhere if it was recent.

Damordaran is great but hard to apply at the level and way we do investing. There are huge imponderables out there, I'd rather let the market put a value on them, and just hitch a (low cost) ride.

My thought is that in theory stocks have infinite upside, and bonds don't. So I'd rather have low risk bonds, and take the flyer on stocks.
zotty
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Re: Emerging Markets Bonds

Post by zotty »

I think it depends on the role of bonds in your portfolio?

I'm a "bonds are for safety" person. In times of crisis, it's hard to beat TBM, well, risk adjusted. 30 year bonds the best, but too much interest rate risk along the way. if bonds are a ballast, like me, it's hard to beat a treasury heavy bond portfolio.

If you were going for diversification, well, you've got it! If that was the original goal, then it's time to accumulate into your weakest performing asset, stocks or EM bonds.

I think you have to be honest with yourself though, were you reaching for yield in a yield starved environment? I play headgames with myself OFTEN, so i don't mean that as a rub...
Nadie Sabe Nada
kerplunk
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Re: Emerging Markets Bonds

Post by kerplunk »

Buying emerging markets bonds is like buying a mid-1960s Italian supercar.
Topic Author
Erwin
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Re: Emerging Markets Bonds

Post by Erwin »

zotty wrote:I think it depends on the role of bonds in your portfolio?

I'm a "bonds are for safety" person. In times of crisis, it's hard to beat TBM, well, risk adjusted. 30 year bonds the best, but too much interest rate risk along the way. if bonds are a ballast, like me, it's hard to beat a treasury heavy bond portfolio.

If you were going for diversification, well, you've got it! If that was the original goal, then it's time to accumulate into your weakest performing asset, stocks or EM bonds.

I think you have to be honest with yourself though, were you reaching for yield in a yield starved environment? I play headgames with myself OFTEN, so i don't mean that as a rub...
Yes, but I have owned Emerging Markets Bonds for over 5 years through FNMIX and its performance has been very reasonable. Once the bond market begun to fall as a result of rising rates, I should have known better, but failed to act. Since the 1980s, when interest rates started their long descent, the bond market has been no brainer. Early 2013, when the game began to change, I just "dropped the ball"
Erwin
zotty
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Re: Emerging Markets Bonds

Post by zotty »

Non bogleheaded:

I mess around with my portfolio more than i should. I don't like EM (too much china) but i did buy EM stocks last week. If you think the panic is overdone, then hang tight or buy more.

I don't know, but i do bottom fish when EM hits a certain level. It could crash through it, but I actually think the real world worst is over. China is bailing out shadow banking clients (individuals who bought risky notes thinking they were govt guaranteed). The reported "crisis" is totally noise IMO, but if china were to let those "CDs" default, i think it probably would have been a colossal deflationary event. To me (and my coin tossing self), the crisis has been averted, so I dumpster dived into EM equities.
Nadie Sabe Nada
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nisiprius
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Re: Emerging Markets Bonds

Post by nisiprius »

mpt follower, as best you can, can you go back five years and reconstruct your reasons then for investing in FNMIX?

Were you aware of the higher risk in these bonds, compared to a high-grade intermediate-term U.S. bond fund?

Specifically, were you aware of the (temporary) 35% plunge in FNMIX in 1998 (orange lines on these charts are Vanguard Total Bond for comparison)

Image

and the 25% plunge in 2008?

Image

If so, you understood that these bonds were really quite different from high-grade U.S. bonds, and felt that the additional return was a reward for taking additional risk. And, as this chart shows,

Image

yes, there really has been additional return. A lot of additional return. Over its roughly 20-year life, it's grown NINE-fold while Total Bond was only growing THREE-fold.

Here is the question: when you bought the fund, what had you planned to do when the next 20% or 30% dip came along? Did you write it down? I sometimes do write such things down, but not always, and I literally have made entries in my own investment diary that say "PLAN: Act on impulse." But, if you didn't write it down, do your best to travel back in time and reconstruct your rationale and your plans when you bought the fund.

Image

Over the last year, FNMIX is down about 3.6%. The stock market sometimes moves that much in a single week. Are you acting in accordance with your plan?

Please note: I am not saying you should hold or rebalance these bonds; I don't know, I don't like "risky bonds" myself and don't use them. I have no idea whether the 3.6% drop is all there will be or whether it's the prelude to another 1998. I'm asking you to do your best to remember your plan and make sure you are not making a impulsive change in it.

And be careful about citing interest rates. When I want to do something impulsive, I tend to feel the impulse first, and then my left brain gets to work to come up with some rationale, and I start paying more attention to the expert articles that confirm what I feel like doing. At any given instant in time you will always find experts saying that we are entering a new era, a "new normal," "uncharted waters," a "new economy," "unprecedented in history," "the world changed," etc. etc. etc. It can't be true all the time.
Last edited by nisiprius on Thu Feb 06, 2014 10:58 am, edited 4 times in total.
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lazyday
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Re: Emerging Markets Bonds

Post by lazyday »

Valuethinker wrote:Thank you I shall look up Economist article (
This is the one I meant: http://www.economist.com/news/finance-a ... -extremity

I quoted it on another forum:
http://raddr-pages.com/forums/viewtopic ... =30#p53063
patrick
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Re: Emerging Markets Bonds

Post by patrick »

nisiprius wrote:yes, there really has been additional return. A lot of additional return. Over its roughly 20-year life, it's grown NINE-fold while Total Bond was only growing THREE-fold.
That is quite a lot of additional return. It is even more amazing when you consider that the emerging markets bond fund dramatically outperformed both US stocks and emerging market stocks over this period.
BreakfastTaco
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Re: Emerging Markets Bonds

Post by BreakfastTaco »

Do these charts include the yield?

I had a bunch of FNMIX and earned a healthy dividend which I enjoyed seeing monthly, I barely looked at the principle. I didn't notice a significant dividend change, even when the share price dropped.

I dumped FNMIX I switched into total bond index mostly because I agree that I'd rather take that risk in stocks so I decided to invest into the Vanguard Emerging Market Index Fund Signal shares offered in my 401K.
WhyNotUs
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Re: Emerging Markets Bonds

Post by WhyNotUs »

I have a similar holding in my IRA of FNMIX. It is a small holding compared to Total Bond but was bought to add some yield during QE. No idea what is best for you but I am holding it. I selected it for yield, to avoid a currency play, because it has a long track record and long management compared to peers, and has a decent geographic, majority of bonds are investment grade, and govt to corporate mix. Nothing has changed my opinion to date. As a contrarian, I am tempted to buy a bit more but will hold tight for now.
The fund is a little heavy in Venezuela for my tastes but the emerging markets are full of governments that give me pause.YMMV
I own the next hot stock- VTSAX
lazyday
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Re: Emerging Markets Bonds

Post by lazyday »

patrick wrote:That is quite a lot of additional return. It is even more amazing when you consider that the emerging markets bond fund dramatically outperformed both US stocks and emerging market stocks over this period.
Yes, but look at how high EM bond yield was at the start of the period. Compared to today.

If bond yields are high, there is a potential for high return if there are few defaults.
marcos123
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Re: Emerging Markets Bonds

Post by marcos123 »

patrick wrote:
nisiprius wrote:yes, there really has been additional return. A lot of additional return. Over its roughly 20-year life, it's grown NINE-fold while Total Bond was only growing THREE-fold.
That is quite a lot of additional return. It is even more amazing when you consider that the emerging markets bond fund dramatically outperformed both US stocks and emerging market stocks over this period.
Yes. Which is why I have tended to favor EM bond funds over EM stock funds (although I invest in both). Lazyday makes a very good point though about EM bond yields, which is why I have opportunistically made significant additions to this asset class with the EM taper tantrums (for a long-term hold). I treat EM bond funds as part of my Equity allocation, given their volatility. One local currency flavor that I have liked is PELBX as it is very credit quality-conscious, with no exposure to such countries as Argentina or Venezuela. Given my US tax position, I have mostly invested via a Roth IRA wrapper, as, despite the inability to avail of the Foreign Tax Credit, I have been better off from a total return perspective with the US tax free compounding.
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