{"id":320924,"date":"2015-11-27T00:00:00","date_gmt":"2015-11-27T05:00:00","guid":{"rendered":"https:\/\/www.investmentexecutive.com\/uncategorized\/emerging-markets-bonds\/"},"modified":"2019-10-31T09:12:32","modified_gmt":"2019-10-31T13:12:32","slug":"emerging-markets-bonds","status":"publish","type":"post","link":"https:\/\/www.investmentexecutive.com\/newspaper_\/investment-research\/emerging-markets-bonds\/","title":{"rendered":"Emerging-markets bonds"},"content":{"rendered":"

As investors shun higher<\/strong> yields for the security of major-markets bonds, such as U.S. treasuries and German bunds, emerging-markets bonds are being sold off. That’s because developing countries’ debt is probably going to be harder to repay in the slowing global economy.<\/p>\n

The need to repay debt in major markets’ currencies, such as U.S. dollars (US$), will make debt repayment for developing countries, which often are commodities exporters, even harder. No wonder investors are heading for the exits.<\/p>\n

For financial advisors, the shift reflects a groundswell in risk management. There is a lot of emerging markets’ debt to repay. New issuance of sovereign debt among these countries doubled in the first half of 2015 to US$210 billion from US$121 billion in 2010, according to the International Monetary Fund. That bump in issuance set the stage for the current sell-off, magnified by declines of emerging markets’ currencies.<\/p>\n

The Brazilian real tumbled by 25% in the first 10 months of 2015; the Turkish lira and the Colombian peso both dropped by 20% in the same period. Those plunges made investors in the corporate bonds of emerging markets demand an extra 3.8% yield over U.S. Treasury bond rates. However, that extra yield is not as high as the 9.9% premium that emerging-markets bonds fetched in 2008 at the height of the global debt crisis.<\/p>\n

Flight from emerging markets shows up in investment flows. Capital Economics Ltd., a consultancy based in London, U.K., says that more than US$260 billion flowed out of emerging markets in the third quarter of 2015. The result has been collapsing prices in emerging-markets debt priced in US$ and, of course, rising yields.<\/p>\n

An example: on Oct. 30, Indonesia’s 10-year government bond yield on debt repaid in US$ increased to 8.80% from 8.71% the previous day.<\/p>\n

Other developing markets’ yields are soaring. Brazil’s 10-year US$-denominated government bonds offered 15.89% in mid-October, while India’s 10-year government bonds paid 7.64% in US$. Turkish 10-year government bonds priced in US$ paid 9.54% in mid-October.<\/p>\n

In the midst of slowing world demand for loanable funds – the core determinant of interest rates – U.S. bellwether 10-year treasuries that pay 2.34% are appealing. So are 10-year Government of Canada bonds, which pay 1.73%.<\/p>\n

But the caution flags are out. Higher yields reflect higher risk, after all. The question is whether all the risks now are fairly priced.<\/p>\n

Countries risk trouble when they issue debt in a currency that is not their own, says Chris Kresic, partner and head of fixed-income at Jarislowsky Fraser Ltd. in Toronto.<\/p>\n

Rising U.S. interest rates and the resulting increase in the exchange value of the US$ will make servicing outstanding US$- and other major currency-denominated debt harder for developing countries. Says Kresic: “It’s a virtuous circle when the US$ is falling and a vicious circle when the US$ is rising.”<\/p>\n

Emerging-markets US$- or euro-pay bonds are not the only ones in trouble. Investors with emerging-markets bonds repaid in the local currency have to carry foreign-exchange risks related to those currencies. From Colombia’s peso to Turkey’s lira, many emerging markets’ currencies have fallen to post-Second World War lows against the US$.<\/p>\n

For bonds repaid in US$ – the largest block of outstanding emerging-market debt that is not repaid in local currency – issuers have had to reach deep into their pockets to pay interest. As a result, bond investors may worry that issuers will run out of dollars and default on their debt.<\/p>\n

There is also a problem of debt levels in emerging markets. The Hongkong and Shanghai Banking Corp.’s foreign debt research department in London, U.K., produced a research report in October that shows that companies based in emerging markets have an average debt level of 90% of their respective nations’ gross domestic products.<\/p>\n

Overall, emerging-market corporate debt denominated in US$ has risen from US$100 billion in 2009 to US$900 billion in 2015, according to an October survey by SG Economics, a London, U.K., unit of Paris-based Soci\u00e9t\u00e9 G\u00e9n\u00e9rale SA.<\/p>\n

The combination of foreign-exchange risk and high underlying debt levels are pushing investors to head for major-market fixed-income investments, pending the U.S. Federal Reserve Board’s widely anticipated decision to start raising rates in December.<\/p>\n

Looking ahead, if the Fed raises interest rates as expected, then there will be a rush to buy US$ assets and movement out of emerging markets and other debt, says Jack Ablin, executive vice president and chief investment officer at BMO Harris Bank N.A. in Chicago. Most sovereign emerging-markets debt has been issued in US$ since the Asian contagion in 1997 and 1998, he notes. Corporate issuers also have tapped the US$ global pool.<\/p>\n

Notes Ablin: “I think that [bond investor] anxiety exceeds the probability of defaults, but price reflects perceived risk.”<\/p>\n

The big question: will current valuations of emerging-markets debt hold or drop further?<\/p>\n

“High yields already reflect bargain-basement pricing, yet the downward trend of bond prices is continuing,” Kresic says. “Emerging-market bond valuations are already cheap in relation to G7 bonds, and the rising U.S. dollar will put pressure on those bond prices, forcing yields higher. But 80% of the revaluation is already priced in.<\/p>\n

“The average spread of emerging-markets bonds over G7 bonds over the past 12 years has been 4%,” Kresic adds. “Now, you are getting 5.75%, which is a good deal. But [emerging-markets bonds] are not for the faint of heart. There is more volatility in [these] bonds to come.<\/p>\n

“Add to that the difficulties of trading emerging-markets bonds,” he continues, “and you see that they are for the nimble, the connected and the patient.”<\/p>\n

\u00a9 2015 Investment Executive. All rights reserved.<\/p>\n","protected":false},"excerpt":{"rendered":"

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