Markets Review & Outlook: First Quarter: Debt Investors Venture Far - Money Floods Into Emerging Markets in Bid to Bolster Returns; Flying BRICs
By Matt Wirz
Last March, Russian investment bank VTB Capital ranked fifth in underwriting Central and Eastern European bonds behind global powerhouses like Barclays PLC and Citigroup Inc. Then, it opened a New York office. Now, VTB has leapfrogged to No. 2 for bond sales fr om the region, with $5.8 billion this quarter, triple the amount it sold in the first period of 2012, according to data provider Dealogic.
State-owned VTB's rise up the investment-banking ranks highlights the vast pools of capital in New York and other global financial centers that are flowing toward emerging-market debt.
"The importance of our New York office is difficult to overstate," said Andrey Solovyev, who runs the bank's global debt capital-markets division from Moscow. The move gave VTB direct access to U.S. institutional investors who are buying emerging-market bonds, both sovereign and corporate, to escape rock-bottom yields at home. U.S. funds now buy up more than half of the bonds the bank brings to market, Mr. Solovyev said.
As the Federal Reserve, the European Central Bank and the Bank of Japan continue to pump cash into developed country bond markets, they keep pushing yields lower and driving investors toward emerging markets. "After all this quantitative easing, everyone is realizing they need to invest elsewh ere," Mr. Solovyev said. "This certainly created a good environment for Eastern European borrowers."
Eastern Europe isn't the only region to benefit from the trend. Borrowers in the BRIC countries—Brazil, Russia, India and China—sold a record $176.36 billion of bonds in the first quarter, up 17% from last year, while bond sales fell 10% in the U.S. and 20% in Europe during the same period.
To be sure, while many emerging-market countries have cut debt and strengthened economic drivers, they remain subject to political risk that can catch investors wrong-footed. Venezuela reminded bond buyers of those pitfalls in February when it devalued its currency 50%, sending its foreign-currency sovereign bonds tumbling 7.5%.
Still, investors see room for growth in emerging markets. In a survey conducted by Barclays last month, 350 investors picked emerging markets second most likely to provide the best returns in the next three months, behind stocks but ahead of corporate bonds, commodities and government bonds.
"The yield in emerging markets is quite good, around 5% to 6%," said Karthik Ramanathan, director of bonds at Smithfield, R.I.-based Pyramis Global Advisors, which managed $71 billion of fixed-income assets at the end of 2012. In comparison, the Barclays U.S. Aggregate Bond Index, which tracks Treasurys, corporate and mortgage-backed bonds, yielded 1.85% at the end of March. Another draw is the improved credit quality of emerging-market borrowers compared with their developed market counterparts, he said.
Credit risk is most commonly measured through a borrower's leverage, which compares debt outstanding to earnings, with higher leverage implying higher risk. The ratio of government debt relative to gross domestic product in emerging markets fell to 42% in 2012 from 48% in 2000, while it rose in heavily indebted developed countries to 110% from 72%, according to research by Ashmore Investment Management Ltd., a $71 billion emerging-markets-focused asset manager. While typically insular U.S. institutions are starting to invest more in emerging markets, even more money is coming from Asian and European pension funds, private banks, sovereign funds and asset managers. Japanese investors, in particular, are fueling the boom.
Falling Japanese government-bond yields and the depreciating yen are likely to induce Japanese investors to move between $700 million and $1 trillion to foreign investments over the next year, according to research by HSBC Holdings PLC. While those flows were initially aimed at Europe, they now are making their way into emerging markets, from Indonesia to Mexico to Poland, according to the bank.
As investor appetite has increased, yields in these markets have fallen. Ten-year Indonesian bonds yielded 5.6% in late March compared with 6.6% in June, while Mexican 10-year yields fell to 5% from 6.25% over the same time period, according to FactSet.
In a new twist, the buyers can request bonds denominated in a currency other than that in a borrower's country of origin to better match their investment strategy. Last month, HSBC placed $38 million of Mexican peso-denominated bonds for the National Bank of Abu Dhabi at a yield of 6.22%, Mr. Pascoe said. "We've been very active in linking them with some of our bigger emerging-market clients," he said.