Publications
Partners
London - Shove over, emerging markets - high-yield debt has taken your place.
Emerging-market bonds, star performers just a year ago, are being replaced by high-yielding corporate debt from developed markets by investors searching for yield.
Emerging debt has fallen out of favour for many reasons. The United States began tapering monetary stimulus as its economic outlook improved. Treasury yields rose, encouraging developed world investors to bring money back home.
That led to an emerging-market sell-off and growth downgrades in emerging markets, particularly those dependent on foreign investor flows.
Add to that political flare-ups from Caracas to Kiev, plus the uncertainty of elections this year, and emerging debt markets have lost the appeal which saw them enjoying record-low yields only a year ago.
Demand has shifted to global high-yield bond funds, which have seen $22bn of inflows since the beginning of last year, according to data from Boston-based fund tracker EPFR. Emerging-market debt has seen outflows of $38bn.
To investors for whom safe-as-houses US Treasuries aren't attractive enough, high-yield developed-world corporate debt - with "junk" ratings below BBB-minus - bridges the gap.
"People are going out of emerging-market debt and into high-yield, it's the only game on now," said Tim Dowling, a senior fund manager at ING Investment Management in New York.
Crossover
Greater sensitivity to risk has translated into steadily rising yields on emerging debt. As a result, yields on emerging sovereign debt have crossed over to become higher than US high-yield.
Since the crossover in late 2013, the spread between the two has widened further, with emerging sovereign bonds now yielding 6 percent, on average 80 basis points more than US junk debt and more than 300 bps above US Treasuries.
A year ago, yields were 90 bps below US yield.
Analysts say crossover investors - those without a particular loyalty for one asset class - have taken money out of emerging markets and stuffed it into high yield.
Targets include companies such as US wireless giant Sprint, which issued one of the biggest high-yield deals of last year, a $6.5bn two-tranche bond, now trading 10 points above issue price. .
"To put the current disdain for emerging market assets into perspective, last time retail outflows from EM equity and debt funds were this severe and persistent was during the 2008 global financial crisis," said analysts at Merrill Lynch.
Wider emerging-market spreads reflect heightened investor perception of risk, particularly in the debt markets of troubled economies called the Toxic Trio - Argentina, Ukraine and Venezuela.
"Emerging markets are showing up as very cheap compared to US high yield, but probably for a good reason," said Scott McKee, lead portfolio manager for emerging markets corporate debt at JP Morgan Asset Management.
"We have seen more flows into US high-yield in the last few months than emerging market sovereigns or corporates."
Frothy?
Global high-yield corporate-debt issuance totalled a record $460bn last year, according to Thomson Reuters data. Emerging sovereign and corporate debt also saw record volume, more than $400bn, according to bank estimates, as borrowers dashed to lock in low interest rates.
But emerging-market returns turned negative as funds fled, and debt sales have dried up during the political crises of the last few weeks, particularly the Russia-Ukraine standoff.
Only 23 emerging-market bonds launched in the first two months of 2014, according to Thomson Reuters data, compared with 63 bonds in the first two months of last year.
High-yield issuance is also lower than last year. But investors put this down to uncertainty over US regulatory changes, which has curtailed the leveraged buy-outs for which companies often issue debt.
Demand is still strong, investors say. Sectors such as US energy, booming because of shale gas, remain attractive.
Global high-yield default rates, an obvious flashpoint for investors in risky corporates, are at historically low levels of less than 1%.
But as with emerging debt last year, some fund managers say the high-yield market is getting frothy.
Default rates are poised to rise, with restructuring fears hitting companies such as US firm Momentive Performance Materials.
The relentless drive into high-yield has also compressed spreads to cycle lows, leaving some to question whether yields can continue to fall.
"High yield is a market into which too much money is going," said Yves Bonson, the chief investment officer at Pictet Wealth Management, who prefers to find yield in safer long-dated US Treasury bonds, avoiding corporate default risk.
"As long as things are going OK, the (high-yield) market is OK, but there are big fat tail risks.
