Remember the days when countries like Argentina would give bondholders a bloody nose and whip their shirt? When debt restructuring was just a long name for default?
Well, no more.
It’s as if emerging markets have suddenly become cautious, responsible adults.
Take Mozambique. The world’s seventh poorest country spent almost a year dangling the “D” word over the bond market in official statements. Investors braced for a slap in the face with a wet fish. The tuna bonds, as they were known for their opaque references to investment in trawling and maritime security in the Mozambique Channel, plunged in value.
And then came the long-awaited announcement. On a day the country was due to pay millions of dollars in interest to its investors earlier this month, the government instead told them it needed a three-year breather on its $850 million burden.
So far, so normal.
But then the story changed. Egged along by the bond’s underwriters, Credit Suisse and VTB Capital, the government gave investors an early Easter present, offering more in compensation for the additional three years of risk than even the most bullish could have dared hope for.
By the end of the process, its creditors were looking at zero capital loss and new bonds that were the direct obligations of the government rather than a state-backed company, reducing their risk. Prices soared.
It’s reminiscent of the last sovereign debt restructuring – by Ukraine. With reasonable excuse as Russia ripped her country apart, Ukrainian Finance Minister Natalie Jaresko – widely predicted to become the next prime minister – demanded bondholders accept a 40% capital loss. She spent months at creditor committee meetings hard-balling investors like Franklin Templeton.
And then came the U-turn.
Ukraine halved its proposed writedown to just 20% – and even for that reduced “haircut” compensated investors with higher interest payments and bonus warrants tied to economic growth. All told, Ukraine may end up paying more to bondholders than had been due before the deal. Unsurprisingly, Ukrainian bonds were the world’s top performers last year.
With amicable arrangements from the most vulnerable countries, and Argentina no more the market’s bad boy, it’s becoming tough to point the finger with confidence at any potential sovereign defaulter, Exotix Partners’ head of research, Stuart Culverhouse, commented earlier this month.
So have developing world governments suddenly found universal faith in their bonds to capitalism?
“There is a broader theme here,” Aaron Grehan, who helps manage $4.5 billion in emerging market bonds at Aviva Investors in London, says on this week’s Emerging Opportunities radio show. “It’s that there is an increasing need for sovereigns to be particularly investor-friendly, because they are now more reliant on investors and the markets.”
When investors were falling over themselves to pour money into any asset offering positive interest rates, high-yielding frontier governments could get away with a bit of misbehaving.
“In the case of Mozambique, there is a need to achieve a kind of fair compromise, and one that avoids a potentially very complicated legal process,” says Grehan.
Seller’s Market
So, could this year’s emerging-markets rebound reduce discipline once more? Stocks have climbed from the lowest in 6 ½ years by 20% for a bull market and local-currency bonds soared 9% in dollar terms on signs the U.S. Federal Reserve will keep global borrowing costs near zero.
It’s unlikely the bond buying momentum is strong enough just yet for any borrower to relax. The rally hasn’t yet made up for the 16% bond loss last year, points out Grehan, let alone the negative couple of years before that. “It’s less of a seller’s market, relative to the periods in 2012 and 2013 when there were such strong inflows into the asset class.”
It looks like governments may be curbing their behavior for a while longer.
Emerging Markets Outlook: Aviva Investors
The Aviva Investors Emerging Markets Bond Fund, which Aaron Grehan co-manages, outperformed 94% of its peer group for the past year, according to data compiled by Bloomberg. The following are edited highlights from Grehan’s interview with Frontera’s Gavin Serkin on the Emerging Opportunities show:
Gavin: How much further is there for this rally to run?
Aaron: We have seen strong returns year to date, but put into a broader context, a longer-term context, we still feel that there’s potential for an attractive return from the emerging-market universe.
Gavin: This emerging markets rally has really taken everything up with it – even Brazil, despite the latest twist in its widening corruption scandal as President Dilma Rousseff attempted to shield her predecessor and mentor, former president Lula, by appointing him to her Cabinet so he’d have political immunity. Brazil’s judges halted his appointment, but the markets in Brazil have been rallying, partly because it puts another nail in the coffin of the Rousseff government. So, are the markets right on this? Where will this political crisis go next?
Aaron: Well, it has been a pretty indiscriminate rally, as you said, and though you have seen what are perceived to be positive developments in Brazil because of this expectation of political change and transition to a more investor-friendly or growth-friendly political regime, it really is a complex process that we’re looking at, and we feel that the market may be getting a little carried away with its positive view of these developments. Brazil has given you some reason to be more positive, but we think that that it’s perhaps been taken too optimistically. The move by Dilma to bring in Lula as chief of staff has somewhat backfired and we’re now looking at an impeachment process that’s likely to be brought forward, versus a couple of weeks ago.
Gavin: So, a bit more cautious on Brazil than the market?
Aaron: I think you have to be, because you’ve seen no real fundamental improvements over the course of the last two or three months, and although political change could be a positive, it’s a pretty big if. We don’t understand the timing around impeachment and what we’re looking at as a political alternative. I mean, it is very much a crisis that you’re seeing in Brazil, and I think too much hope is being given to a positive change without yet enough information as to what that new regime could look like and what changes are likely to be introduced over the next several months, or even two or three years.
Gavin: I want to turn to companies now, because you’re very much focused on corporate debt within emerging markets in your day-to-day investment management, and we’ve seen corporate bonds holding up lately. Where do you see the opportunities in this market?
Aaron: I think it’s an important point that you make, that corporate bonds have held up well, and that’s something that we’ve seen over a number of years now. If you look back at 2013, emerging market corporates had a flat return for the year, whereas hard-currency sovereign and local markets were very negative. So, that resilience is something that’s been proven historically.
The corporate universe has continued to grow in terms of outright size as well as the number of issuers and bonds out there, and that provides a greater opportunity set, so we’ve now got a broader universe that provides us with more opportunities to try to access attractive returns and attractive long term corporate stories.
We’re looking at the select emerging market companies that offer attraction in global commodities because of their positions as low-cost producers, and that gives them a greater ability to be more competitive on a global scale.
Also, in contrast to the caution around the Brazilian sovereign, we feel that the corporate sector in Brazil has some great examples of companies that are isolated from some of that sovereign concern. And more generally, Latin America is where we see the greatest value. It’s the Latin American region where there’s that perception of crisis but, within a good stock picking process, you can find great opportunities.
Gavin: Where are the areas that you apply more caution?
Aaron: It’s more about knowing the details from the bottom up in that commodity space. There are some great examples of companies that we feel will be global survivors, as well as some companies that have become over-levered and are likely to encounter some financial difficulties over the next two to three years if prices stay this low. So, it’s really about assessing the universe from the bottom up, making sure that the portfolio is exposed to the highest quality names regardless of the sector or region.
Gavin: One other development in the past week has been Egypt, which has moved to more of a flexible exchange rate. Egypt is one of those countries that was really digging its heels in like Nigeria, keeping to this fixed exchange rate. What’s the significance of what Egypt has done?
Aaron: Well, that is very much a losing battle on something that they had to give into. The devaluation of the Egyptian pound is broadly a credit positive, and it does provide some kind of shorter and longer-term benefit, but really, there are a number of challenges that are facing Egypt, and this just allows them to be able to adjust, to fight those challenges better. But it’s still a story that we feel remains challenged.
They still have significant financing needs; they’re very reliant on the GCC countries. That support seems to have decreased, or certainly has the risk going forward of decreasing because of the financial difficulties that those countries find themselves in with the lower commodity price outlook. There is, on the beneficial side, the existence of the IMF, and that could provide some near term support for asset prices as the collaboration with the IMF would counter some of the worries about those financing needs.
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