A new frontier for yield

With developed market bonds yielding record low returns, fund managers are venturing into frontier and emerging markets – notably in Africa, the fashionable destination for intrepid investors.

Ethiopia, for instance, is seeking to raise up to $1bn (£630m) with a 10-year bond, following a recent roadshow to European and US investors. The aim is to build roads, railways and hydroelectric dams.

Rated B1 by Standard & Poor’s and B by Moody’s and Fitch Ratings, Ethiopian sovereign debt is well into junk bond territory. Yet this has not deterred pension funds, insurers and sovereign wealth funds from subscribing to the issue.

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The bonds are expected to generate a yield of approximately 6-7 per cent a year, compared to consensus forecasts for emerging market debt of 4 per cent (down from 9 per cent), according to Amin Rajan, chief executive of Create Research.

Meanwhile, former Barclays chief Bob Diamond is targeting Africa’s banking sector through his Atlas Mara vehicle, and private equity group KKR recently took a $200m stake in a Kenyan flower farm.

Retail fund managers are also eyeing esoteric plays. One is Mary-Therese Barton, an emerging market debt manager at Pictet Asset Management, who plans to take advantage of higher-yielding markets such as Lebanon and Vietnam. Unlike the debts of China, Malaysia and Mexico – which move with US Treasuries due to their dollar peg – these countries’ debts move in relation to domestic issues, she says.

Martin Harvey, deputy manager on the Threadneedle Global Opportunities Bond fund, says he has increased exposure to “quality markets” such as Mexico and Columbia. At the same time Zsolt Papp, who works on the emerging market debt team at JPMorgan Asset Management, says it has taken tactical trading positions in Brazilian debt after the price fell and the yield rose correspondingly.

The team is also reviewing the Ethiopian bond issue. “Like with any emerging market debt investment, if it carries a strong growth story and good valuations, then it is something we would consider gaining exposure to,” Mr Papp says.

Anthony Gillham, who co-manages multi-asset funds at Old Mutual Global Investors, thinks emerging market government bonds issued in local currencies are currently among the best value assets across the entire fixed income spectrum.

“Yields are above 6 per cent, which compares very favourably with developed market government bonds, particularly when you risk-adjust these yields,” he says.

“A 10-year gilt offers just 25 basis points in yield per year of duration, whereas Brazilian 10-year government bonds offer approximately 2 per cent yield per year of duration.”

He thinks many of the factors that have held back emerging market currencies since 2013 are abating, which will boost bonds denominated in those currencies. Indonesia has stabilised its balance sheet in terms of imports versus exports, he says, while weaker commodity prices have been a tailwind for nations such as Turkey.

“Given such reasonable valuations in the more mainstream parts of the asset class at the moment, I question whether it is necessary to move into frontier markets such as Ethiopia, particularly at a time when market makers are structurally pulling back from providing secondary market liquidity,” adds Mr Gillham.