GLOBAL investors have swept risk fears aside and have piled into emerging market bonds.
Global rating agency Moody’s estimates that between 2010 and the first quarter of 2019, emerging market (EM) municipalities, other “sub-sovereigns”, corporations, financial institutions, infrastructure and project finance entities issued bonds worth some US$3.8 trillion.
More than half of all EM bonds issued in 2018 and the first quarter of 2019 were by Asia-Pacific borrowers. Such has been the search for high yielding securities, that EM companies accounted for over $1.6 trillion of international bond issuance during this period.
To cope with the demand, Moody’s currently rates 1,660 issuers from 71 EM countries. Latin America and the Asia-Pacific account for 37 per cent and 30 per cent of total EM issuers, respectively.
The risk proportion has increased as Moody’s states that as many as 59 per cent of some 700 non-financial corporate issuers are classified as high yield and most of the borrrowers are in China, Russia and Brazil.
Moody’s rates a growing number of EM issuers as “stable”. It estimates that 88 per cent of Asia-Pacific sovereign debt is stable, But 20 per cent of African and Middle Eastern nations “have a negative outlook”.
The ratings, however, are based on economies that are growing. The danger is that “global economic stress will weigh unevenly on emerging-markets business conditions through 2020”.
“Corporate sectors in the biggest emerging-market economies face a number of common risks in 2019,” said Moody’s. “They include slower global growth, variable market sentiment, shifting trade policies, and geopolitical, environment, social and governance risks.”
Pension funds & institutions sanguine
Many pension funds, other institutions and individual investors have chosen to turn a blind eye to the risks because of EM bonds’ relatively high interest payments.
For example, the iShares JP Morgan USD Emerging Markets Bond ETF (exchange-traded fund) has a 5.6 per cent yield, while Invesco Emerging Markets Sovereign Debt ETF has a yield of 4.8 per cent. These ETFs invest in a variety of bonds across several emerging nations.
Such has been the surge in issues to provide the thirst for yield that the Switzerland-based Bank For International Settlements (BIS) estimates that net outstanding developing nations’ international debt securities (after redemptions) amounted to $2.54 trillion in the third quarter of 2018.
Developing Asia and Pacific nations account for US$778 billion of that total.
Total international bonds outstanding on global markets $24.3 trillion
The global bond market has grown into a massive size. The BIS estimates that the total amount of international debt securities outstanding in developed and emerging nations amounted to a whopping $24.3 trillion in the third quarter of 2018.
Financial corporations dwarfed government holdings by a massive proportion.
Beware of credit risks
As stated in a recent editorial in The Business Times, investors should be wary of bonds that have not been rated.
Analysts working for Moody’s S&P and other rating agencies are hopefully carrying out intensive analysis of the accounts and future policies.
If the agency downgrades a bond and lowers the rating of a nation, the bond price would tend to decline. If the bond rating is upgraded, the security’s value would increase. Sovereign bonds only have interest rate risk, in which the bond price declines if interest rates rise and appreciates when interest rates fall.
Political developments such as Brexit can also have an impact on sovereign bond valuations. But with corporate and other non-sovereign bonds there is also a credit risk alongside interest rate risks.
In other words, if the company has cash flow problems and is already over-indebted, the price could weaken regardless whether interest rates fall or rise.