Monday, 18 June 2018

EM hysteria is overdone: take the money and run

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Keith Mullin is concerned by the flood of first-time issuers from the emerging markets

IFR Editor-at-large Keith Mullin

IFR Editor-at-large Keith Mullin

I HOSTED IFR’S 2012 Emerging Market Debt Outlook Conference in London on September 18. It was a jolly affair and I had a fabulous time. I’ve been around EM debt for more than 25 years now but in all those years, I don’t think I’ve ever encountered such a wave of euphoria towards the asset class.

Take a look at the international bond pipeline and you’ll encounter the likes of first-timers Paraguay, Bolivia, Rwanda, Kenya, Tanzania and Uganda at the sovereign level as well as a long list of exotic banks and corporates priming their international debuts. Year-to-date, there’s been a steady stream of EM debutants from across the globe and investors can’t get enough of them. I’m concerned.

In recent days, there have been some, let’s say, interesting developments: Trade & Development Bank of Mongolia garnered a US$1.2bn book for its US$300m of three-year notes, while Angola’s US$1bn seven-year 7% loan participation note soared by 4-1/2 points in the grey market. Zambia tightened guidance on its US$750m debut 10-year international bond and printed at 5-5/8% – through similarly-rated Ghana and close to higher-rated Nigeria – and still pulled in US$12bn of orders from 420 accounts. Oh, and Nigeria 2021s are trading around 5%-flat; Namibia not far behind at 5-3/4%.

Turkey, a mainstream issuer these days, built an US$8bn book for its US$1.5bn 5.5-year debut dollar sukuk issue; pricing through its conventional curve with a 2.8% yield that is in Single A territory rather than Turkey’s actual rating in the Double B area.

SOME YEARS BACK, I used to chat to a guy called Henry Avis-Vieira who ran an exotic debt boutique long before frontier markets were fashionable. Back in the day, we used to print a weekly table of his indicative prices – mainly defaulted loans and trade paper – from some of the scariest places on the planet. Henry referred to them as hyper-exotics. It was a market for specialists. Hyper-exotics these days are being viewed as spread paper by increasingly mainstream investors. I don’t think it’s a good fit.

Considering EM as a discrete asset class is no longer in vogue. Borrowers from countries formerly known as emerging markets have now moved up the pecking order and we’re now supposed to consider them an integral component of global bond portfolios. We’re also supposed to refer to them not as emerging markets but as Global Growth Markets, New Markets or use annoying euphemisms like N11.

In today’s world of zero interest rates, investors have rushed headlong into anything that’ll offer them a semblance of return

In today’s world of zero interest rates, investors have rushed headlong into anything that’ll offer them a semblance of return. That has pulled everything from investment-grade corporate debt to high-yield to EM into levels that don’t reflect the inherent risk. And now that external debt offers such poor risk-return, some of the more adventurous mainstream interest is – worryingly – shifting to EM domestic currency markets, not just in Asia and Latin America but in Africa too.

The massive bid for EM is purely technical. Alas, the people – and there were many of them at our shindig – who tried to convince me that the huge down-shift in yields and the willingness to accept exotic names in the primary market at ridiculous spreads is built as much on fundamentals, have, I fear, fallen for their own spiel.

Fundamentals may indeed be improving across the spectrum against any number of macroeconomic yardsticks, but let’s face it: they’re improving from a pretty low base in many cases. EM investment flows are not built on fundamentals; they’re built on momentum. EM has been ring-fenced from non-EM for a reason: they’re vulnerable to heightened event risk and can suffer brutal and rapid contagion effects. For a start, they’re extremely exposed to reversals in capital flows: Turkey, for example, relies on foreign inflows to finance its current account deficit. In bad times, those inflows can be extremely fickle.

PEOPLE TALK OF event-risk shifting from emerging markets to peripheral Europe and refer to EM as a safe haven. OK the Greek debacle makes it easier to argue the point, but it’s still scary talk. Safe havens they ain’t. The track record of many emerging markets on political stability, economic self-sufficiency, corruption, rule of law, bankruptcy and insolvency codes etc is far from convincing. EM is still a market for specialists.

Rwanda is a case in point. Economists laud the country’s economic strides since the genocidal war of the 1990s. But remnants of that war are still being waged, with heavy Rwandan involvement in brutal fighting in neighbouring DRC. Understanding Rwanda is not a question of looking at its GDP growth.

But momentum is a wonderful thing. JP Morgan’s decision to include Nigerian domestic debt in its government bond index (GBI-EM) plus marginal real-money re-allocations to EM will result in continuing inflows: just a 1% allocation shift by US real money accounts will result in a US$1.2trn inflow to EM. That will only push the asset class into even more heavily over-bought territory.

Be sure: at the first sign of trouble – and there will be trouble – the specialists will get out fast and the real-money momentum players who arrived late to the party are likely to get crucified.

The frontier funds, meanwhile, are buying stuff that’ll make your toes curl. One guy said he was looking to gain exposure to South Sudan. Remarkably, at the end of the conference, someone asked me for his phone number because he had a deal to show him. Definitely time to take the money and run.

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