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Investors cautious about dollar bonds from Nigeria, others

By on January 10, 2015

Investors are turning more cautious about dollar bonds from ‘frontier’ markets – a fast growing but less developed and higher risk sub-set of emerging economies – due to sliding oil prices, low trading volumes and expectations of smaller returns.

Within the diverse group of economies, which ranges from Belarus and Belize to Egypt and Pakistan, interest is likely to shift in 2015 towards energy importing nations that will benefit from cheaper crude, and away from oil exporters.

According to Reuters, debt issuance by frontier countries is a small proportion of the total for emerging markets, which are dominated by bigger names such as Brazil or Russia. But their governments have made the most of investors’ hunt for better returns while interest rates in developed economies remain ultra low.

According to Thomson Reuters data, frontier countries sold $19.7bn in hard currency debt last year – an almost 50 per cent rise from 2013 and nearly three times the 2012 level.

Yet many, especially oil exporters such as Nigeria and Ecuador, are likely to be hit hard this year by the dramatic drop in crude prices, said Kevin Daly, portfolio manager at Aberdeen Asset Management’s emerging debt team.

“The outlook is tenuous for some countries, given the sensitivity for oil,” said Daly. “Investors will be a little bit more circumspect and demand a higher risk premium when it comes to these kind of commodities-sensitive countries in the current backdrop.”

With emerging market sovereigns overall issuing just over $100 billion in hard currency bonds last year, frontier markets remain a niche investment but they have been a rewarding one.

Anyone who bought bonds from the around 30 countries in the benchmark JPMorgan Next Generation Emerging Markets index would have made a return of just over 10 per cent last year. That compares with seven per cent for mainstream emerging sovereigns or 3.6 per cent for emerging market corporate debt.

Few believe this performance can be repeated in 2015, but Aberdeen’s Daly expects a still healthy 4-5 percent return across NEXGEM in 2015. Roy Scheepe, senior client portfolio manager at ING Investment Management predicts 7-9 per cent.

Almost all of the world’s fastest growing economies in recent years fall into the frontier category, he points out.

“Fundamentals might be a little bit weaker, but for investors there is always the issue of alternatives – it’s not as good as it was, but then look at everything else,” said Scheepe. ING IM has $550m of its assets under management in frontier markets, mostly hard currency debt.

Among these alternatives are German 10-year bonds, yielding as little as 0.44 per cent, or Brazil, whose dollar bond maturing in 2043 yields just over five per cent.

Investors are focusing on Asia – a region heavy in oil importing frontier countries such as Sri Lanka, which is holding closely-fought elections this week. On the flipside, they are averse to crude producers, especially sub-Saharan African economies like Angola, Nigeria or Gabon.

Overall, weak economies and falling oil prices bring more risk, making it costlier for governments to raise foreign capital. The cost of servicing dollar debt is also likely to rise once the US Federal Reserve raises interest rates, a move widely expected to come at some point this year.

Paul McNamara at investment management firm GAM, which has $5bn under management and invests in frontier debt, expects a lot of opportunistic issuance this year, making it hard to predict overall volumes.

“Relatively few of these countries will have external issuance as core part of their budget or balance of payments for the year,” said McNamara, investment director at GAM. “In most cases, they can manage without, but they will issue … if they can.”

JPMorgan expects issuance across NEXGEM countries to amount to $15.5bn this year. Investors say the sector’s small size and high risk has in fact shielded frontier debt, as it tends to attract buy-and-hold funds with a high risk tolerance.

The number of issues has grown from eight in 2012 to 18 last year. However, a lack of liquidity has prevented many investors from buying into frontier market debt, especially in uncertain times, and that is unlikely to change, says ING IM’s Scheepe.

 

 

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