Outlook for emerging market bonds

“Emerging Market Bonds: Are You Being Paid for Risk?” was the subject of a Boston Security Analysts Society panel moderated by William L. Nemerever, partner and co-manager, global fixed income group, Grantham, Mayo, van Otterloo & Co. on January 23.

Their bottom line: Emerging market (EM) bonds are fairly valued and their near-term outlook is excellent. Years ago EM bonds used to be considered risky, even speculative. That has changed. Now they’re just another part of the global bond universe, said David W. Rolley, co-head of global fixed income, Loomis Sayles & Co.

During the past couple years, EM spreads have tightened and even become tighter than corporate bonds with similar ratings, said John Peta, portfolio manager, emerging market strategies, Standish Mellon Asset Management. Why? He cited factors including:

· Improved credit ratings

· Broader investor base due to strategic inflows and local investors

· Less vulnerability due to abandonment of fixed exchange rates

Rolley played up the role of 28 years of 10% GDP growth in reducing the volatility of the EMBI Global index. But low volatility can’t persist forever. “Volatility is too low. EM governments will provide it themselves by misbehaving,” he said.

Citigroup’s Don Hanna, managing director, head of emerging market economic and market analysis, identified three trends keeping EM bond spreads tight:

· Globalization

· Financial innovation

· Better government policies

Risks loom in each of these sectors over the longer term.

The downside to the greater stability of EM bonds is they don’t offer as much portfolio diversification as in their more volatile days. Perhaps the last stronghold of diversification lies in local currency EM bonds, suggested Rolley.

P.S. When I subsequently discussed this presentation with some BSAS members over lunch, they were concerned that it didn't spend much time on the risks from the carry trade or the fact that investors are not being well-compensated to take on risk. What do you think?