Posted: 04/12/2012
Ashburton's head of Asset Allocation, Tristan Hanson gives his outlook for emerging market bonds in 2013.
2012 has seen another year of heavy flows into emerging market bonds ($40bn so far, according to Barclays) and both hard currency and local currency bonds have been strong performers. It is not hard to understand why investors have increased allocations to EM debt – excessive sovereign debt levels and negative real interest rates in the G7 creates a powerful force in search of yield. As a result, foreign ownership of EM bond markets has increased significantly.
However, after such strong performance, spreads on hard currency EM bonds are now approaching the pre-Lehman lows achieved during the mid-2000s credit bubble. In terms of local currency debt, real interest rates have collapsed in most EM countries (Figure 1), as concerns over weak global growth and currency appreciation have dragged policy rates lower.
Generally speaking, low real rates may be here to stay as long as monetary policy remains loose in developed markets. But it is also likely that low rates make EM bonds a riskier proposition going forward. Bond market performance may become more divergent and currency movements will likely become the dominant driver of returns.
Nonetheless, there can be no doubt as to the current level of enthusiasm for emerging market debt. The recent 10-year bond issues by Bolivia, Mongolia and Zambia at interest rates of 4.9%, 5.1% and 5.4% respectively (US$) should settle the debate. According to reports, this was the first time Bolivia has issued sovereign debt since the 1920s. Similarly, in the case of Mongolia, a country reportedly bailed out by the IMF on five occasions in the past 22 years, the issue size was not far shy of 20% of GDP. Meanwhile, Zambia's bond issue was 24 times oversubscribed according to a statement on the Ministry of Finance's website.
Global bond investors may need to tread carefully over the next year or two.
Figure 1-Red indicates developed market, source: Bloomberg