Bubble risk as “tourist” investors flood into emerging market debt


LONDON: Double-digit returns in emerging market corporate debt have spurred a record buying spree, forcing yields to 13-month lows and raising the risk that an external shock, potentially from the U.S. or Chinese economies, might produce a dramatic exit.

Dollar debt issued by firms from riskier and less developed countries has been among the year’s best performing assets, yielding more than 11 percent, according to JPMorgan’s emerging market (EM) corporate debt index, the CEMBI Broad.

The average yield has fallen 150 basis points (bps) this year to about 5.2 percent, dropping more than both EM sovereign debt and developed-country corporate debt yields, which have been falling due to Western central bank bond-buying schemes.

Investment-grade U.S. corporate debt yields average 3.3 percent, equivalent sterling-denominated bonds yield 1.8 percent while euro-denominated equivalents are even lower.

In the past six weeks, investors have pumped a $18 billion into emerging debt funds, a record run, Bank of America Merrill Lynch data shows. A significant part of this will have flowed into corporate bonds, analysts say.

Investors attribute much of this exuberance to funds that do not normally invest in emerging markets, “tourists” or “cross-over” investors, who have ventured in solely for yield.

PineBridge Investments’ emerging corporate debt analyst John Bates, whose firm has nearly $81 billion of assets under management, sees this factor as a risk.

Developments, such as a change in U.S. interest rate expectations or concerns over the Chinese economy, can put such investors to flight, because unlike dedicated EM debt managers they are less used to the sector’s volatility, he said.

“These are tourists with very fat pockets. Typically EM is a small allocation within a big pension fund or asset allocator, so if you get a big fund dipping into that pool, and then removing that money there could be some very severe repercussions,” Bates said.

EM corporate bond markets may be seeing an “investment balloon effect”, he said. “This hunt for yields is driving spreads tighter, and it is pretty indiscriminate, and even heavier the further down the credit spectrum you go.”

But for global investors, saddled with more than $10 trillion of negative-yielding developed markets bonds, the average 340 basis-point premium the CEMBI pays over U.S. Treasuries may be too much of a lure.

Single B-rated emerging firms – carrying so-called junk credit ratings – have garnered returns of more than 20 percent year-to-date, according to the CEMBI Broad’s high-yield subset.

Bates cited the example of Indian renewables firm Greenko, which this month sold a single-B rated $500 million 7-year bond with a 4.875 percent yield, half a percent tighter than initial guidance. Orders amounted to a hefty $4.5 billion.
Seasoned investors may point to International Monetary Fund warnings last week of corporate defaults in China, where 14 percent of debt is estimated to be from firms whose profits are less than the interest they pay on loans.

“A lazy approach to corporate debt, seen as a nice spread pick-up over the sovereign, is a dangerous investment strategy,” BNP Paribas Investment Partners deputy-head of emerging debt, JC Sambor, said.

But some argue that against the backdrop of developed bonds, bumper yields on a sector with an average BBB-minus investment grade rating can hardly be considered a bubble.

Also, fears about the sector’s indebtedness are overblown, Commerzbank corporate debt strategist Apostolos Bantis said.

He estimates emerging companies’ ratio of debt to EBITDA – earnings before interest, depreciation and amortisation – at 2.5-3.0 percent on average, is a similar level to U.S. investment grade firms and half that of junk-rated U.S. issuers.

“Fundamentally, emerging market corporates are in better shape than U.S. high-yield and are comparable with U.S. investment-grade,” Bantis said.

Tight supply, an added factor in the rally, could also change soon because both emerging market companies and sovereigns face “a wall of maturity” as the huge debt volumes raised during the boom times come due for repayment. About $1.6 trillion falls due in the coming five years.

Added to that, new bonds have been scarce this year, with gross issuance not seen exceeding $220 billion, JPMorgan says, down from $239 billion last year and $372 billion in 2014.

This is exacerbated by companies rolling over debt and buying back bonds. As a result, net issuance may total just $102 billion this year, JPMorgan estimates.

However, Aviva Investors’ deputy head of emerging market debt, Aaron Grehan, whose firm has nearly $415 billion in assets under management, sees no risk of a bubble and says that crossover investors’ appetite should encourage more issuance.

“The spread tightening we have experienced is likely to trigger greater issuance versus expectations,” he said.