Global Investing

Junk-rated EM sovereigns — so last year

March 15, 2013

With rising U.S. Treasury yields posing a threat to emerging debt.  JP Morgan is now advising investors to cut holdings of sovereign dollar bonds to marketweight from overweight. And it suggests doing that by reducing exposure to the riskiest (and usually the highest-yielding) emerging markets, listed on its NEXGEM sub-index.

These bonds, with high yields and low credit ratings, basked in the glow of investor appetite last year when U.S. and German bonds were yielding next to zero and the  euro zone looked in danger of falling apart. Emerging debt issuance last year topped $300 billion while junk credits such as Zambia and Guatemala saw massive demand for their debut bond sales.   (Sales of junk-rated corporate bonds likewise boomed in the yield-seeking frenzy).

But with frontier markets now accounting for more than 75 percent of net new sovereign issuance, some jitters could be growing. Even Angola, which issued a private placement last year, is now in JPM’s  EMBI Global index , though analysts think a recent private placement from Tanzania may not make it. Crucially, returns on emerging dollar bonds are among the worst of major asset classes this year at minus 2 percent (compare that to 9 percent gains on the S&P500)

Risk isn’t all bad though – JPM suggests staying overweight emerging market corporates, even though in this market too, junk-rated issuers have been increasing their share.  Returns on the CEMBI (corporate emerging bond index) are just above flat for the year but JPM reckons that EM corporate bonds’  ”relative value remains attractive against U.S. credit”.

And among those frontier sovereign bonds, JP Morgan advises holding on to Angola and Sri Lanka but to cut Gabon, Iraq and Mongolia’s development bank.  It also suggests an overweight on Venezuela but to sell Ukraine – struggling to agree an IMF deal  and  Argentina, where the risk of default remains.

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