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Johannesburg - Look anywhere in the world and you’ll be hard-pressed to find an investment that’s as profitable and safe as the dollar-denominated bonds of higher-rated companies in developing nations.
Their 5.6% rally this year, while not the biggest in absolute terms, eclipses more than 130 assets from UD Treasuries to gold and even bitcoin when volatility is factored in, according to data compiled by Bloomberg. The 19% jump in Colombian stocks might sound like a better deal, but price swings in Bogota exposed investors to six times more risk. When both factors are considered, the gains in emerging-market corporate dollar bonds come out twice as good, the data show.
That marks a turnaround for the securities after last year’s selloff fueled by concern higher US interest rates, currency swings and a slowdown in China’s economy would spur corporate defaults in emerging markets. Now investors are returning, buying the bonds of borrowers such as oil-company Petroleos Mexicanos and Brazilian iron-ore exporter Vale SA in a low-volatility sector yielding an average 2 percentage points more than Treasuries.
“There was too much fear earlier and the selloff went to ridiculous levels,” said Luc D’Hooge, who oversees $700m as head of emerging-market bonds at Vontobel Asset Management in Zurich and bought Latin American investment-grade notes including Pemex and high-yield credit in Africa this year. “The bottom line is that the default risk in emerging markets is not massive. The spreads we saw last year were unjustified and that’s what has led to this performance.”
The travails of 2015 prompted economists from the International Monetary Fund to the Bank for International Settlements to warn investors that weakening currencies would raise the cost of repayment in emerging markets and lead to increased defaults. The threat failed to materialize this year as state support, hedging strategies and a recovery in exchange rates helped companies not only to pay off their debts, but also refinance at lower costs.
Investor appetite
That boosted investor appetite for developing countries, helping sovereign and corporate bonds in both investment and high-yield grades to post the best four performances in a broad swathe of global assets. An analysis of 65 stock markets from Canada to New Zealand, currencies from the US dollar to Danish krone, commodities including oil and orange juice, treasuries, corporate bonds and the biggest exchange-traded funds failed to show a better score on risk-adjusted returns.
The bounce-back in oil and commodity prices played a key role in the performance. Companies from these two industries dominate the sweepstakes in emerging-market bond gains. The 2042 notes of Brazil’s Vale and 2022 notes of Mexico’s Industrias Penoles SAB de CV have returned more than 17% this year.
Optimism about growth has returned, too. Signs of stability in China, an acceleration in India’s economy and brighter prospects for energy-exporting countries such as Russia present a contrast to last year when the air was thick with the talk of slowdowns and recessions. The growth differential between emerging markets and developed markets is set to widen this year and the next, HSBC Holdings Plc predicted this month.
The rally has been marked by continued pessimism among some money managers and could fizzle out with a change in any of the factors including the Federal Reserve’s dovish stance, China’s stimulus plans or the stability in crude prices, some analysts say.
“It’s a reluctant type of rally,” said Larry Hatheway, the chief economist at GAM Holding AG in London. “What certainly propels it is the absence of alternatives.”
Hatheway, who still sees value in the Mexican peso and to a lesser extent the South African rand, said it’s "tough" to find many favorites after gains in the past two months.
"Extreme pessimism"
Others see a need for continued caution against gains overshooting fundamentals.
“We were coming off extreme pessimism last year,” said Alberto Gallo, the head of macro strategies at Algebris Investments Ltd. in London, who sees value in European financial debt and U.S. high-yield corporate bonds. “It is too early to call it an extraordinary whole year. Investors still need to be very selective about what they buy.”
In the developing world, Gallo sees promise in Argentina, as well as countries with less exposure to commodities like India and Mexico.
For now, investors are seeking to escape almost $8trn of global sovereign notes that offer nothing more than negative interest rates. Emerging markets help them in three ways: their bonds typically have higher rates, with those issued by investment-grade borrowers being relatively safe, and the dollar securities among them strip out the currency risk.
“Now people are asking why invest in bonds with negative yields because you’re sure to lose money,” Vontobel’s D’Hooge said. “If you are ready to accept a little bit of risk and volatility, you can make much more returns.”
