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.
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.
Mr Papp argues esoteric corporate bonds are not necessarily less safe than esoteric government bonds, since their issuers recognise they could be shunned by the capital markets if they fail to meet their debt service obligations.
This pressure is perhaps more potent where companies are concerned, he says, because governments can rely on financial support from supranational lenders such as the International Monetary Fund.
He adds that investors should differentiate between fundamentally sound sovereign issuers and those facing a deteriorating or vulnerable macro backdrop.
“One of the main factors is the ability to absorb potential contagion from global financial market events, such as higher bond or foreign exchange market volatilities or a hike in US Treasury rates,” he says.
Mr Papp favours countries with strong solvency and foreign currency reserves, low debt ratios and no problems refinancing their budget or current account deficits.
“As commodity and energy prices look likely to stay under pressure, we believe commodity importers are better positioned than exporters, including central-eastern European issuers such as Hungary or Slovenia, but also South Africa, India and Panama,” he predicts.
Mr Papp says average emerging market debt yield and spread levels look attractive, with the company’s index of emerging market government bonds trading at approximately 350bps, implying an average yield of roughly 5.7 per cent.
Even with the recent rises in Russian, Brazilian and Venezuelan yields, he thinks emerging market debt offers attractive relative value, but cautions that risk-averse investors should maintain a broadly diversified portfolio.
This does not necessarily mean developed market debt should be substituted for emerging market debt, he says, but that it might suffice to add some emerging market debt to an existing portfolio to improve its Sharpe ratio.
“If investors decide to replace developed with emerging market debt, we would suggest maintaining a similar rating and duration distribution in the new portfolio, in order not to radically change underlying portfolio risks and interest rate sensitivities,” Mr Papp says.
