Emerging market debt continues to be a popular choice among investors who are not risk averse a...
Emerging market debt continues to be a popular choice among investors who are not risk averse and who are seeking high yields.
Paul Barnes, markets and strategic development director at Standard & Poor's, says investors in search of high yield have on the whole shown a robust risk appetite, although buyers remain discriminating to some extent.
Most of the interest has been centred on just a handful of the 45 countries that make up the world's emerging markets, he adds.
By region, EEMEA has attracted the most investment, with inflows of $18.5bn, but is closely followed by Latin America and other markets in the western hemisphere at $15.6bn and Asia at $14.8bn, Barnes notes. He says: 'The popularity of these issues is understandable after years of depressed equity and bond markets. Return from emerging market debt has been estimated at around 15.1% during the last year and about 13.2% a year over the past 11 years.'
According to Standard & Poor's analysts, global default rates are steadily declining, although in the EU, the 12-month average default rate of speculative grade issuers remains high at more than 12%.
However, globally, 1.4% of speculative grade issuers and 0.5% of all rated issuers defaulted in the first quarter, compared with 4.1% speculative grade and 1.5% of all issuers in the first quarter of 2002. Barnes says: 'The downward trend in defaults has been enough to tempt some investors back into the high-yield market, as well as emerging markets.'
Flows into investment grade and high yield corporate bond funds have also helped support emerging market bonds.
Many fund managers have taken temporary positions in the higher yielding and more liquid market for emerging market debt while they wait for openings in the high yield corporate sector.
Risk to the asset class springs from the increasingly narrow spreads in emerging market issues, which may lead to bouts of profit taking by investors. Over the current seven month rally the EMBI spread declined by about 600 basis points compared with an average of 220 basis points over a similar period in the previous three rallies, Barnes says. 'Only the bonds issued by the Dominican Republic have undergone a widening of spread. The spread on Brazilian bonds, by contrast, has narrowed from 2,300 basis points to just 730 basis points over US Treasuries.'
According to Aberdeen Asset Management, some emerging market areas have made interest rate changes, affecting the appeal of sovereign bonds. The Hungarian central bank increased interest rates by 2% to 9.5% after recent weakening of its currency. The group says the central bank is hoping the increased real rates will attract yield investors and support the weakening currency. The Brazilian central bank did the opposite, cutting interest rates 50 basis points to 26%. More cuts are expected in the short term, according to Aberdeen's economists.
Strategists at JPMF note the move by Brazil hurt its equity market. The first reduction in Brazilian rates since July 2002 was initially welcomed by investors but the central bank's commitment to an aggressive inflation target suggests further interest rate cuts are unlikely in the short term.
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