EM bonds have generally performed very well over the last quarter. Arguably one of the main drivers of this has been loose monetary policy enacted by the world’s major Central Banks, which have pushed yields down to historic lows – or even into negative territory in some instances.
US 10-year government bonds are yielding 1.86% while comparable Gilts and Bunds are offering 1.25% and 0.17% respectively and in Japan, 10-year government bonds are offering a yield of -0.06% according to Bloomberg. Such low returns have led to a global ‘hunt for yield’, which has seen EMs benefit from non-traditional EM investors picking up such assets.
However, estimates of EM holdings from crossover (non-traditional EM) investors are currently low, and are within single digits – around 3% according to Sean Newman, senior portfolio manager, emerging markets at Invesco.
“There is certainly scope for this weight to increase. However, these investors are not dedicated long-term investors, and usually represent a headwind for the markets during increased volatility,” he said.
Some distortions are appearing, however. According to another senior investor, while EM HY has not got more expensive, the premium on EM HY over US or European HY assets has disappeared. Although this has happened in the past, it has never occurred for such a sustained period of time.
“There is now nothing to separate EM HY and US and European HY. This has been the case all year, said the investor.
They added that whilst not all HY credits are yielding all-time lows, the difference between such assets across EM and DM is.
Nevertheless, there is still value to be found in higher-yielding assets across EM, particularly from across commodity-related entities, which tend to be in a worse position or closer to default than other names.
“The BB equivalent rating category looks fairly fully valued, in some cases even slightly rich,” noted the investor. The farther down the credit spectrum you go, the better values you get.
“The distressed pool has never been bigger, and distressed assets as a whole do not look particularly expensive.” This asset class has been particularly prevalent across Latin America as there have been numerous defaults across the region this year, noticeably in Brazil.
However, higher-quality EM credits have seen distortions in some regions because of the influx of investors into the asset class.
Shifting liquidity plays a central role here – for instance, anticipation of increased activity in the Middle East following Saudi Arabia’s US$17.5bn bond sale earlier this month has pushed investors to allocate elsewhere, impacting pricing in places like Turkey.
“Despite losing its investment grade rating, a military coup attempt, military incursion into a neighbouring country, falling tourism revenues and occasional domestic violence in certain regions as well as a large terrorist group on its border, Turkish bond prices still do not move,” the investor said.
Since mid-July, Turkey’s 10-year government bond yield has remained in the mid-to-high 9% area according to Trading Economics, and was earlier this week yielding 9.71%. The country banks also continue to issue. Vakifbank, Aktif Bank, Turk Eximbank and IS Bank have all successfully placed bonds this month.
Despite the volume of issuance from the Middle East in recent months however, the region’s credit is not trading at all-time lows. The investor noted that there was not a lot of evidence behind the theory that Middle Eastern HY was overpriced or in a bubble.
“Other credits alongside Turkey, such as Ukraine and parts of Africa look a lot more overpriced than the Middle East. Although it is hard to find bonds that are ridiculously overpriced for their fundamentals, one or two may exist.”