Jonathan Mann, head of emerging market debt at F&C, shares his views on emerging market debt. Compared to developed markets, emerging economies are proving more robust and investor opportunity is increasing in this sector, Mann argues.

Emerging market growth versus developed market

Since 2007 and the ensuing collapse of Lehman Brothers, the credit crunch, global economic downturn and the eurozone sovereign debt crisis, various developed markets saw and are still seeing downgrades in their credit ratings, while the opposite is happening for some emerging economies, Mann says.

Over this period the demand from emerging market debt investors has been such that the number of countries issuing offshore sovereign bonds denominated in US dollars increased from 36 to 57. New issuers included Angola, Bolivia, Costa Rica, Mongolia, Morocco, Namibia, Sri Lanka and Vietnam, and further issuers expected to come to the market in 2013 may include Kenya, Bangladesh and Thailand.

The total outstanding stock of the countries comprising the JP Morgan EMBI Global Index in terms of eligible sovereign and quasi-sovereign debt is increasing, and is up 23.6 per cent since 2008 to reach $458.6 billion last year.

One of the main attractions for investors is also that the opportunity for diversification is growing rapidly. For issuers the key factor is they are usually able to borrow at lower yields and for longer maturities in international markets than in their domestic markets.

A new generation of EMD issuers

Just as credit ratings for emerging market debt issuers have progressively improved, a similar change has been seen in newer emerging countries, Mann points out, whose sufficient political and economic stability enables them to begin accessing international debt markets.

In addition, with a growing number of traditional EMD issuers now carrying investment grade ratings, investors are looking further afield for yield and capital growth potential, at the next generation of EMD issuers.

This growing interest in the next generation is reflected in JP Morgan’s NexGem Index launched in 2011; the index now comprises 24 issuers, five of which were added last year, namely Angola, Bolivia, Guatemala, Mongolia and Zambia.

What Mann stressed was the need for investors to undertake their own research including country visits, to find out about the economic and political trends in each country so as to make an informed judgement on whether the spread is too wide or too narrow, instead of relying on research reports.

For investors, there is return potential from accessing this new generation of countries on an opportunistic basis, increasing allocations within a more mainstream portfolio when conditions are supportive. Investors who are focused on sovereign debt, with a risk controlled approach, can capitalise on these opportunities, he said.

Case studies: Angola and Azerbaijan

Two countries that Mann’s research highlighted were Angola and Azerbaijan.

As Africa’s second largest oil producer, Angola controls state-owned Sonangol whose target output is two million barrels a day by 2017. Oil exports and foreign loans have driven economic growth, estimated at 6.8 per cent in 2012, and fuelled a reconstruction boom, with China as one of its main customers. However, approximately 40 per cent of the population are still living below the poverty line, which means both political and economic risk is high.

Similarly, Azerbaijan has become one of the world’s fastest growing economies due to the accelerated development of its oil and gas reserves, and the country has accumulated a sizeable foreign exchange reserve buffer of 60 per cent of its GDP. It is also running a positive current account balance, 10 per cent of GDP, and has one of the lowest public debt levels globally, at just 11.5 per cent of GDP.

Conclusions

“The next generation of emerging debt markets clearly offers exciting income and growth potential to fixed income investors, but they are not without higher associated risk. Key to success in this area will be the detailed understanding of the political and economic drivers at work within each economy,” Mann concluded.

“With these issues in mind we believe that exposure to the next generation markets is best achieved from within a broader EMD portfolio on a tactical basis as market conditions dictate, and we expect 2013 to offer a number of such opportunities,” he said.