Emerging market investors are turning to data on income inequality, corruption and debt insurance costs to help them make decisions about buying sovereign debt, as official credit ratings come under fire. Ratings firms have been under scrutiny since the global credit crunch three years ago, after giving little or no warning of one of the biggest credit implosions in history.
More recently, euro zone policymakers have accused ratings agencies of being overly harsh on indebted euro zone nations - prompting counter-charges that the officials are just resisting unwelcome news.
For emerging market funds, many of which are used to analysing countries without official credit ratings, one solution is to construct their own models for investment, drawing on evidence such as lobby group assessments of political risks, as well as data on economies and public finances. "We would never make an investment on the basis of what a rating is or is expected to be; we make all investments according to our analysis," said David Dowsett, head of emerging fixed income at BlueBay Asset Management.
"Ratings are not irrelevant, obviously, they open up a sector to different pools of sub-investors, but they are certainly not a key driver of our operations."
Credit ratings measure the borrower's ability to repay debt in full and on time.
Fitch's methodology for sovereign ratings, as an example, focuses on macroeconomic performance, the economy's vulnerability to shocks, public finances and external finances.
"We use a shadow rating - what we think the rating should be and what we think the ratings agencies think it should be," said Stuart Culverhouse, chief economist at frontier markets brokerage Exotix.
Angola was rated for the first time earlier this year, at B+, when Culverhouse thought the country merited a B rating.
"There is opaque policy-making, communication with the market could be better - there is an issue about transparency," he said of Angola.
Exotix has started to use other indices besides official ratings, and has found a closer link with bond spreads.
Exotix plotted ratings against bond spreads, then added data from the UN's Human Development Index, Transparency International's Corruption Perception Index and the Heritage Foundation's Index of Economic Freedom.
"This data shows that the bond market penalises corrupt, less free and less developed countries more than the ratings alone would predict," Exotix said in a note.
Using ratings adjusted with the addition of the indices, debt in Senegal and Angola looks less attractive than before, but Macedonia and Ecuador look more attractive. Uruguay also fares well.
"It scores the best among frontier markets on the additional risk factors, such as corruption and human development. We would expect that the rating agencies will recognise its merits over the next few years," Exotix said.
Investors point to the importance of visiting countries, and meeting policymakers, to gauge how fast an economy is growing.
"If you want to make an investment decision and just use the rating, are you going to know where the fiscal and monetary policy is going, where interest rates are going to be a year from now?" said Werner Gey van Pittius, strategist for Investec's emerging bond funds.
Van Pittius said plotting ratings against credit default swaps could also throw up investment opportunities.
"If the CDS are trading wide of the ratings, the market is expecting a downgrade, or it's cheap and you should buy it."
Credit default swaps that imply a higher sovereign rating include Turkey, analysts say. Turkish five-year CDS, the benchmark for debt insurance, are trading below 200 bps, compared with CDS around 800 bps for troubled euro zone member Greece, even though Greece still has higher credit ratings.
While many investors can only invest in countries with a certain official rating - generally from B to BB for emerging market investors - others do not mind if a country does not even have a rating, and some ignore ratings altogether.
The emirate of Dubai, which issued debt in international capital markets prior to a shock debt payment standstill last year by state-owned Dubai World, does not have a rating.
Data from Dubai is not always easily accessible, but generally, analysts and investors can do a lot of the ratings agencies' work on public finances on their own.
"You do your own homework, you get the ratios yourself," said Tim Ash, Head of CEEMEA research at RBS.
"World Bank data, IMF - you can do your own comparisons, there is enough data available."
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