Global Investing

Braving emerging stocks again

It’s a brave investor who will venture into emerging markets these days, let alone start a new fund. Data from Thomson Reuters company Lipper shows declining appetite for new emerging market funds – while almost 200 emerging debt and equity funds were launched in Europe back in 2011, the tally so far  this year is just 10.

But Shaw Wagener, a portfolio manager at U.S. investor American Funds has gone against the trend, launching an emerging growth and income fund earlier this month.

It’s a great time to launch a fund if you have a long-term focus in mind. Emerging markets trailed DM in terms of performance for a while, peaking at end of 2010 so we are 3-plus years into a down market and period of significant underperformance.

He may be onto something. Some analysts have tentatively started advising clients to start dipping their toes back into water, given how cheap emerging market valuations are. Societe Generale for instance which has been negative on emerging equities for 3 years, said in a note that the sector had gone from being “priced for perfection to deep value”.

Emerging equities trade around 10 times forward earnings, compared to 14 for their developed counterparts and down from 13 times back in 2010.  Check out this graphic by @ReutersFlasseur: http://link.reuters.com/rut87v

CORRECTED-Toothless or not, Western sanctions bite Russian bonds

(corrects last paragraph to show that Timchenko was Gunvor’s co-founder, not a former CEO)

Western sanctions against Russia lack bite, that’s the consensus. Yet the bonds of some Russian companies have taken a hit, especially the ones whose bosses have been targeted for visa- and asset freezes.

Take state-run Russian Raiways. Its chairman Vladimir Yakunin, a member of President Putin’s inner circle, was on the sanctions list. He said he was flattered to be targeted but investors in his company’s dollar bonds are likely to be less thrilled. Russian Railways’ 2022 bond is now the cheapest quasi-sovereign bond in the emerging markets universe relative to its sovereign, Barclays analysts point out. The bond trades now at a 158 bps premium to Russia’s 2022 issue while the one-year average premium has been 114 bps, Barclays note.

Ukraine aid may pay off for Kremlin

Ukraine said today it was issuing a $3 billion in two-year Eurobonds at a yield of 5 percent in what seems to the start of a bailout deal with Russia. That sounds like a good deal for Kiev — its Eurobond maturing next year is trading at at a yield of 8 percent and it could not reasonably expect to tap bond markets for less than that. In addition,  Ukraine is also  getting a gas price discount from Russia that will provide an annual saving of $2.6 billion or so.

But what about Russia? Whether the bailout was motivated by “brotherly love” as Putin claims or by geo-politics, it sounds like a rotten deal for Moscow. The credit will earn it 5 percent on what is at best a risky investment. What’s more the money will come out of its rainy day fund which had been earmarked to cover future pension deficits. State gas company Gazprom will have to stomach a 30 percent price cut, which according to Barclays analysts is “a reminder of the risks of Gazprom’s quasi-sovereign status.”

But there could be positives.

Putin is clearly playing a long game that aims not only at giving the Kremlin tighter political control over Ukraine but also to bring it back into the Russian gas sales orbit and eventually create a bigger trade bloc encompassing Russia, Kazakhstan and Ukraine, says Christopher Granville, managing director of consultancy Trusted Sources in London.

Barclays sees 20 pct rise in EM bond supply in 2014

Sales of dollar bonds by emerging governments may surge 20 percent over 2013 levels, analysts at Barclays calculate.  They predict $94 billion in bond issuance in 2014 compared to $77 billion that seems likely this year. In net terms –excluding amortisations and redemptions — that will come to $29 billion, almost double this year’s $16 billion.

According to them, the increase in issuance stems from bigger financing needs in big markets such as Russia and Indonesia along with more supply from the frontiers of Africa. Another reason is that local currency emerging bond markets, where governments have been meeting a lot of their funding needs, are also now struggling to absorb new supply.

The increase is unlikely to sit well with investors — appetite for emerging assets is poor at present, EM bond funds have witnessed six straight months of outflows and above all, the projected rise in sovereign supply will come on top of projected corporate bond issuance of over $300 billion, similar to this year’s levels. (See graphic)

Turkish savers hang onto dollars

As in many countries with memories of hyperinflation and currency collapse, Turkey’s middle class have tended to hold at least part of their savings in hard currency. But unlike in Russia and Argentina, Turkish savers’ propensity to save in dollars has on occasion proved helpful to companies and the central bank. That’s because many Turks, rather than just accumulating dollars, have evolved into savvy players of exchange rate swings and often use sharp falls in the lira to sell their dollars and buy back the local currency. Hence Turks’ hard currency bank deposits, estimated at between $70-$100 billion –  on a par with central bank reserves — have acted as a buffer of sorts, stabilising the lira when it falls past a certain level.

But back in 2011, when the lira was in the eye of another emerging markets storm, we noticed how some Turks had become strangely reluctant to sell dollars. And during this year’s bout of lira weakness too, Turkish savers have not stepped up to help out the central bank, research by Barclays finds. Instead they are accumulating dollars — “rather than being contrarian, their behaviour now seems aligned with global capital flows,” Barclays  analysts write. While the lira has weakened to record lows this year, data from UBS shows that the dollarisation ratio, the percentage of bank deposits in foreign currency, has actually crept up to 37.6 percent from 34.5 percent at the start of the year. Here’s a Barclays graphic that illustrates the shift.

What are the reasons for the turnaround? In the past, those selling dollars to buy back cheap lira could be confident they would not be out of pocket because the central bank would support the lira with higher interest rates.  But ever since end-2010, when the bank embarked on a policy of determinedly keeping interest rates low, they no longer have this assurance. Barclays write:

Bond market liberalisation — good or bad for India?

Many investors have greeted with enthusiasm India’s plans to get its debt included in international indices such as those run by JPMorgan and Barclays. JPM’s local debt indices, known as the GBI-EM,  were tracked by almost $200 billion at the end of 2012.  So even very small weightings in such indices will give India a welcome slice of investment from funds tracking them.

At present India has a $30 billion cap on the volume of rupee bonds that foreign institutional investors can buy, a tiny proportion of the market. Barclays analysts calculate that Indian rupee bonds could comprise up to a tenth of various market capitalisation-based local-currency bond indices. That implies potential flows of $20 billion in the first six months after inclusion, they say — equivalent to India’s latest quarterly current account deficit. After that, a $10 billion annual inflow is realistic, according to Barclays. Another bank, Standard Chartered, estimates $20-$40 billion could flow in as a result of index inclusion.

All that is clearly good news, above all for the country’s chronic balance of payments deficit. The investments could ease the high borrowing costs that have put a brake on growth, and kick-start the local corporate bond market, provided more safeguards are put in. Indian banks that have traditionally held a huge amount of government bonds, would at least in theory be pushed into lending more to the real economy.

Frontier markets: past the high water-mark

By Julia Fioretti

Ethiopia’s plans to hit the Eurobond trail once it gets a credit rating are highlighting how fast frontier debt markets are growing.

IFR data shows that sub-Saharan Africa alone issued $4.2 billion of sovereign debt in the year to September, compared to $3.6 billion in the same 2012 period. And returns on frontier market bonds have outgunned their high-yield emerging sovereign peers this year.

JPMorgan, which runs the most-used emerging debt indices of which the frontier component is called NEXGEM, says the year-to-date return on NEXGEM is around 0.7 percent – while paltry, it’s well above corporate and sovereign emerging bonds.

With pension reform, Poland joins the sell-off. More to come

If the backdrop for global emerging markets (GEM) were not already challenging enough, there are, these days, some authorities that step in and try to make things even worse, writes Societe Generale strategist Benoit Anne. He speaks of course of Poland, where the government this week announced plans to transfer 121 billion zlotys ($36.99 billion) in bonds held by private pension funds to the state and subsequently cancel them. The move, aimed at cutting public debt by 8 percentage points,  led to a 5 percent crash yesterday on the Warsaw stock exchange, while 10-year bond yields have spiralled almost 50 basis points since the start of the week. So Poland, which had escaped the worst of the emerging markets sell-off so far, has now joined in.

But worse is probably to come. Liquidity on Polish stock and bond markets will certainly take a hit — the reform removes a fifth of  the outstanding government debt. That drop will decrease the weights of Polish bonds in popular global indices, in turn reducing demand for the debt from foreign investors benchmarked to those indices. Citi’s World Government Bond Index, for instance, has around $2 trillion benchmarked to it and contains only five emerging economies. That includes Poland whose weight of 0.55 percent assumes roughly $11 billion is invested it in by funds hugging the benchmark.

According to analysts at JPMorgan:

The most significant local market impact of the Polish pension reforms is likely to come from index-related selling as the weight of Polish government local currency debt in major global bond indices, including Citi’s WGBI and the Barclays Global Aggregate index, is likely to fall. Our base case scenario sees $3.5 billion worth of index-related selling, with risks skewed to the upside

South Africa may need pre-emptive rate strike

Should South Africa’s central bank — the SARB – strike first with an interest rate hike before being forced into it?  Gill Marcus and her team started their two-day policy meeting today and no doubt have been keeping an eye on happenings in Turkey, a place where a pre-emptive rate hike (instead of blowing billions of dollars in reserves) might have saved the day.

The SARB is very different from Turkey’s central bank in that it is generally less concerned about currency weakness due to the competitiveness boost a weak rand gives the domestic mining sector. This time things might be a bit different. The bank is battling not only anaemic growth but also rising inflation that may soon bust the upper end of its 3-6 percent target band thanks to a rand that has weakened 15  percent to the dollar this year.

Interest rates of 5 percent, moreover, look too low in today’s world of higher borrowing costs  – real interest rates in South Africa are already negative while 10-year yields are around 2.5 percent (1.5 percent in the United States). So any rise in inflation from here will leave the currency dangerously exposed.

The Sub-Saharan frontier: future generations

As growth in Sub-Saharan Africa is set to post a steady 5-6 percent per annum to 2017 according to IMF estimates,  investors will be taking notes on the region’s growth story not least with the financial sector.

Growth projections have rebounded from forecasts of around a 3 percent rise in 2009 after falling commodity prices have hit one of the region’s main revenue sources. Yet, according to the World Bank’s recent Global Development Finance report, stronger commodities will firm growth prospects in the coming years. In recent weeks, commodities have dipped, dampening the outlook for some resource-rich countries, but as 76 percent of the region’s population do not have access to a bank account, lenders are set to grow their presence in the region.

Julius Baer notes the region’s market potential:

Since 2002, resource-hungry China has swept across a by-and-large grateful African continent, taking oil and minerals in exchange for debt relief, low-interest loans, or much needed infrastructure, such as roads, ports and housing.