Appreciating local currency bonds are starting to attract interest by investors hoping to diversify
Emerging markets are a top choice for investors who wish to diversify their assets, but foreign investors remain underinvested in emerging market bonds compared to equities, said Hong Kong-based Joel Kim, head of Asian debt at ING Investment Management.
However, this might be changing. Fixed-income investors who wish to gain some exposure to the appreciating emerging market currencies are now placing their capital in local currency debt.
'We have seen modest outflow from US dollar-denominated emerging market bonds into local currency-denominated emerging market bonds,' said Mr Kim.
Both institutional and retail investors have decided to switch to local currency debt. Mr Kim said sovereign wealth funds that had been actively pumping up liquidity to invest in companies affected by the United States subprime crisis also showed strong interest in local currency debt to diversify away from their US dollar exposure.
Emerging market bonds have been resilient for the past six months.
Mr Kim said hard-currency-denominated sovereign bonds generally produced positive returns last year, despite the turmoil in global credit markets. And they outperformed similarly rated US high-yield bonds.
Overall, the one-year return of emerging market bonds has been about 4.5 per cent compared with a negative return of 3.7 per cent from investing in US high-yield bonds, according to the Lehman Brothers High Yield Bond Index. Mr Kim said that this outperformance could be attributed to vastly improved emerging market fundamentals, and an increased scarcity of sovereign bonds.
Meanwhile, according to the JPMorgan Emerging Markets Bond Index, hard-currency emerging market 13-year bonds are producing a yield of about 6.8per cent.
The performance of the local currency debt market is even more marked. On average these bonds provide a yield of 7 to 8per cent, according to the JPMorgan Global Bond Index for emerging markets. The return of local currency-denominated bonds has been more than 20 per cent over the past year.
Analysts believe there will be a slowdown in the issuance of emerging market debt by corporates in the form of high-yield bonds.
'We have seen a fall in demand in the Philippines for local currency-denominated bonds,' said Frances Cheung, fixed income strategist at Standard Chartered Bank. 'The majority of the local currency-denominated bonds were high yielders. And now investors are switching back to bonds issued by the US Treasury.'
Tony Stringer, managing director and head of Asia-Pacific corporate ratings at Fitch Ratings, said there would be less issuance of high-yield bonds this year.
'All corporates issuance has dried up completely,' said Mr Stringer.
'We are more likely to see potentially stronger credit and investment grade offerings coming from developed countries rather than high-yield bonds issued by China and Indonesia which denominated the debt market in Asia in the past few years. Despite this, the fundamentals of these companies are pretty good in our view. The investor appetite just isn't there for these high yielders. I'd be surprised if we see any high-yield issuance in the second half of the year.'