A very good year for emerging market bonds
2000 may have been a sad year for credit and for high yield bonds in particular, but there were some high yielding bond markets that provided positive returns over the year. Emerging market bonds, as measured by the JP Morgan Emerging Bond Index Global Constrained (EMBI GC) returned around 13% in US dollar terms. Even emerging market equities produced a positive return of some 5%, a good deal more than the sad 10% decline in the S&P 500. As ever, asset allocation was the key. Disparities in performance within the global index were huge – Latin America was beset with a variety of problems, proximity to the US being one of them , while the Asian markets continued their slow rehabilitation from the devastating economic crises of several years’ earlier.
The bond markets of Emerging Europe, the Middle East and Africa (EEMEA) on the other hand, had a notably uneventful year and, consequently, provided the best returns in 2000. Monica Mastroberardino manages the Emerging European bond portfolios for Vontobel and enjoyed 2000, although she says it was tough. “A rising oil price is always bad news for the inflation outlooks in these markets, and we had some difficult times,” she explains, though of course for oil producers such as Russia things were easier. “Last year was not about rate cuts in these markets, in fact only Hungary reduced rates while Poland actually hiked them. All in all, Hungary was a very good market in spite of some horrid third quarter consumer price inflation figures which provoked a rate rise from the National Bank. But of course for bond markets there is always the coupon to smooth out much of the pain and add the value.”
Russian bonds produced the most impressive returns, however, returning a stunning 55%. And, according to emerging market specialist Ashmore Investment Management, this market could be the place to be again this year. Jerome Booth of Ashmore says, “Russia is currently our favourite market for a variety of reasons. The macro picture is very healthy and there are surpluses in both the budget and trade accounts. The authorities have done a huge amount of restructuring, and have radically changed the tax system for example. In the bad old days they failed to raise any money, and now fiscal revenues are actually increasing.”
According to Booth, the dramatic and devastating crisis of 1998 has, ironically resulted in the creation of a much more stable environment. He explains that the enormous amounts of leverage and speculative money in Russia ensured that any ‘accident’ befalling the market would be multiplied hugely. Fortunately the crisis rid the market of the hot money, which then moved swiftly into the NASDAQ and, Booth reckons, will not be coming back.
“Obviously the Russian market has not still fully recovered, and liquidity has not returned to the heady levels of $1.8bn traded daily, but volatility has come right down and a new type of investor, institutional this time, is being attracted into the market,” states Booth. “The risk/reward characteristics have improved hugely,” he adds, “and another element which is attracting the new breed of investors is the realisation of the very low correlation between Russian, and other emerging market, bonds, and other financial asset classes,” he says.
Both Mastroberardino and Booth emphasise investment in the local currency debt, as opposed to dollar-denominated instruments. “Spreads in the dollar markets are boring, frankly,” admits Booth, “It is in the local currency markets where we have been making most of our performance.” Mastroberardino agrees, adding, “Looking at the events of last year where most, but not all, currencies in Eastern Europe were reasonably stable it was the high interest rate local currency denominated paper that yielded the best returns.”
The Polish zloty was one to avoid last year, as political uncertainty weighed heavily on the market and culminated in the resignation of the finance minister, arguably any emerging bond market’s key individual. There has recently been a dramatic change in fortune here, and the zloty has just enjoyed a spectacular rally, says Mastroberardino. “The zloty had become really cheap towards the end of last year, but we now believe that the market has gone too far, and I think it is over-valued against the euro and the US dollar.”
Although gauging the currency to have entered over-bought territory, she thinks that interest rates in Poland are extremely attractive, although bonds have also enjoyed something of a rally. For Ashmore, Poland is also a favoured destination although it comes third on the wish list, behind Russia and Turkey.
“Things are happening in Turkey now,” says Booth, “There is now a tough front-loaded anti-inflationary programme in place. This is really Turkey’s last chance to join the EU. There is still a liquidity problem in the banking sector, and yes things have the potential to worsen, but we are reasonably happy with the prospects for 2001.”