Emerging market debt funds are enjoying a bumper inflow for the first time in three years, but portfolio managers are struggling to invest the bonanza as new bond sales have declined and trading volumes have evaporated.
In a world awash with negative-yielding bonds - more than $10 trillion of the global bond market at last count - and with expectations of further monetary easing rife, there has been a sudden scramble for emerging market debt.
Funds tracked by EPFR Global and J. P Morgan have taken in a net $20 billion so far in 2016. The data, which captures a small slice of the global action, showed a record $4.7 billion in inflows last week.
Most interest has centred on dollar-denominated debt, generally seen as safer than bonds in domestic currencies. And given that new hard currency bond sales have not recovered since the latest emerging markets shakeout in February, a shortage has emerged to drive up prices.
Emerging market companies will not sell more than $220 billion this year, J. P Morgan estimates, contrasting that with the 2012-2014 period when annual corporate bond sales averaged $355 billion. Turmoil in Turkey after a failed coup may impact markets further, with two issuers already postponing their bond plans.
Sovereign debt sales are up this year thanks to mega-deals from Argentina and Qatar. But net new supply, after accounting for maturities and coupon payments, will be just over $50 billion, JPM says.
According Yerlan Syzdykov, head of emerging debt at Pioneer Investments, one of the funds he runs is more than a third larger than it was in early-2016.
"We are happy to have this problem but the difficulty is things are progressively getting more expensive. When money comes in, funds have to buy. Effectively you are a forced buyer," Syzdykov said.
The shortage has cut the average size of secondary market transactions to about $2-$3 million, compared with $5 million as recently as April, he said.
"The situation people are facing is: Close your eyes and abandon your discrimination skills and buy what you can."
This re-emergence of US rate rise expectations - futures now price a 50-50 chance of a Federal Reserve interest rate hike this year - has dampened demand a bit. But markets remain tight with the outlooks for more central bank stimulus in Japan and Europe.
Another investor said that of 650 corporate bonds he had looked at from emerging Europe, the Middle East and Africa, as many as 550 now trade above par. Less than half were above par earlier this year.
He cited the example of a 2026 dollar bond that was issued by Abu Dhabi's state-run utility Taqa in mid-June just under par and now trades at 108 cents in the dollar.
"It's become a big one-way market. Rates will remain low for longer and a lot of this liquidity is ending up in emerging markets," the investor said.
Shrinking trading volumes is not a new problem.
The ability to find ready buyers and sellers of high-risk, junk-rated debt from Western companies and emerging markets has suffered from strict bank regulation since 2008 on how much inventory brokers can hold on their books and the disappearance of proprietary trading at banks.
As a result, market makers - banks that facilitated trading by holding securities on their own books and displaying bids and offers - have all but vanished.
Reuters reported last year that the average stock of an emerging dollar bond traded less than twice a year, down from 4-5 times in 2007.
Falling liquidity means investors are often unwilling to part with assets, leaving "gappy" price moves on the way up as well as down, said Rob Drijkoningen, head of emerging debt at Neuberger Bermann, referring to widening spreads between bids and offers.
The collapse in secondary trade volumes was exacerbated by the fall in new issuance, Drijkoningen said, adding:
"A lot of investors position on the back of new issues. That means there is normally a liquidity channel which is not working at the moment."
Investors' desperation manifested itself during the recent sale of bonds from Israeli drugmaker Teva, where the bidding frenzy was described by one banker as a "bloodbath".
Teva took orders of 25 billion euros for its 4 billion euro bond. Bids for its dollar issue hit $70 billion.
Fund managers also bemoan the disappearance of new-issue premia - the yield pick-up offered to lure buyers to new bonds.
Teva's tranches offered yields up to 35 basis points tighter than existing bonds.
And investors last week were happy to lend Brazil - junk-rated and mired in crises - 30-year cash at 5.875 percent, below the 6.125 percent paid on a 10-year bond in March.
One solution is to veer off-benchmark. The capitalisation of JPM's most-used benchmarks for sovereign and corporate dollar debt is near $800 billion but another $3 trillion in tradeable debt is available outside major indexes, says Jan Dehn, head of research at Ashmore.
Another strategy is to wait for bad news to hit. Pioneer's Syzdykov used a market selloff following Turkey's failed coup to buy bonds at reduced prices. But the technical momentum is masking risks such as those in Turkey, he warned, adding: "Eventually those things will come back to haunt the emerging world."
Comments
Comments are closed.