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The year 2012 will probably be remembered for many things—the London Olympics and the US presidential election for starters— but for investors, it may be the year of emerging market debt. Thus, it might just be a year to forget.
After the quasi-meltdown of the Eurozone and a United States economy that has failed to fire back into life, investors have been looking around for uncorrelated, positive-yielding assets to help them meet their liabilities and diversify their risk budget. Emerging markets are on the top of the pile for many, but not in the way they were before the financial meltdown. Back in the mid-2000s, investors piled into these developing stock markets, but many pulled out at the first sign of trouble in the wider world. Others didn’t move quickly enough and found “liquidity risk” was not just something they read about in the small print at the end of a consultant’s presentation.
This time the story is different: debt, issued in local currency, is the asset class du jour. Because of the heightened risk associated with the asset class, yields are higher than even low-grade developed market corporate debt. According to Thomson Reuters, some $314 billion in emerging market corporate debt was issued last year, and by the end of March this year, some $113 billion had been issued, making it a record quarter. These companies are moving away from issuing in dollars as their own currencies are getting stronger, or else they do not feel the need to attach to the US in order to earn acceptance from investors.
So there’s no shortage of supply and, it appears, no shortage of demand, as large investors across the developed world are tendering for managers offering a way into asset class. But caveat emptor: there’s a reason for the high yield, even if some think this debt might be a touch overpriced. “Investors are either looking at emerging market debt as a strategic investment or a tactical opportunity. Arguably, if they are considering the latter, it’s too late,” says Crispin Lace, Director in Consulting & Advisory Services at Russell Investments. “The potential downside is that there is political risk and correlation with other assets, but additionally emerging market debt is susceptible to panic. At the first sign of bad news, emerging market debt is going to be marked down even if there is no direct link, whereas debt issued by the United Kingdom or the US isn’t.” This is what happens to perceived “risky assets,” of course. No one remembers the financial crisis in South East Asia in 2008, because there wasn’t one, but its markets tanked as investors were spooked by what was happening in developed markets.
Despite emerging markets being less indebted than their overexposed developed neighbours, they are still going to be hit should the world come to an end (almost) again—and like high-yielding assets before them, risk isn’t always where you think it might be hiding.
—Elizabeth Pfeuti