Will Weakening Emerging Market Bonds Get Even Weaker?
Emerging market bonds appealed to income-starved investors in recent years. We had one private investor express interest in Brazilian and other South American bonds a couple of years ago, since the interest paid put U.S. treasuries and corporate bonds to shame. Our client thankfully didn't press for this, since he would have been sitting with substantial losses today.
At the time, we though as we always do: if you're getting a higher return on an item, there's got to be a reason. And the reason presented then was that, while the companies whose bonds we looked at were "solid," the only reason they paid higher interest was that they were located in an emerging country. But, of course, the "emerging" part was the key. In this case, the underlying problems these countries had at the time melted into the background as the economies of many emerging countries continued to enjoy a boom that everyone thought would last virtually forever. (Hmmm...where have we heard that before?) They were the "future" of the world's economic growth vs. the old dinosaur developed countries.
So with the underlying problems now emerging (no pun intended), the bonds that seemed a sure thing don't look so sure anymore. Indeed, we're likely to see some defaults "emerge" in coming months. Perhaps we won't see companies like Brazil's Petrobras default, but certainly anything smaller or less established could be a concern. Worse, we may be seeing the cycle turn against those emerging darlings - the BRICS - who only last year continued to be the place to put your money for the long run, in the considered opinion of so many. If a longer-term cycle of slow growth and even recession takes hold - as it already has in some countries - the bonds of these countries will be a nightmare for anyone who had thought they had a ticket to "income heaven" for the next 5 - 10 years.
Putting that to the side, we came across an article you may want to check out on Bloomberg that takes us through some of the simmering troubles in the BRICS and their little sisters. You see, as these emerging countries and companies face refinancing their existing debt in the next year or so, they're facing having to do so at much higher rates, never a good thing for a debtor who needs to refinance. It's like people who have adjustable mortgages on their homes initially financed at 2% fining out their new rate next year will be 3%. That's a 50% increase in their monthly payment. The same applies to countries and companies:
Well, at least there's one money manager who thinks we shouldn't worry too much. Considering the scenario of companies having to refinance at higher interest rates - which is what's now looming in the coming year - our intrepid money manager shrugs it all off:
So here's where your reason and common sense will help you:
You might think that someone who manages emerging bonds full-time should have a certain expertise in the area that you and I might not have. But think about it. Could this guy ever say that investing in his bonds is far too risky for most of us? Can he afford to say that, since he's most likely compensated based on the amount of bonds he manages? Can you see the conflict of interest here, and do you understand why we never take the advice of such people? Use your common sense here, and you'll most likely agree that a money manager who manages one asset class may be the worst source for understanding either what's going on in the markets, or what may happen in the future.
At the time, we though as we always do: if you're getting a higher return on an item, there's got to be a reason. And the reason presented then was that, while the companies whose bonds we looked at were "solid," the only reason they paid higher interest was that they were located in an emerging country. But, of course, the "emerging" part was the key. In this case, the underlying problems these countries had at the time melted into the background as the economies of many emerging countries continued to enjoy a boom that everyone thought would last virtually forever. (Hmmm...where have we heard that before?) They were the "future" of the world's economic growth vs. the old dinosaur developed countries.
So with the underlying problems now emerging (no pun intended), the bonds that seemed a sure thing don't look so sure anymore. Indeed, we're likely to see some defaults "emerge" in coming months. Perhaps we won't see companies like Brazil's Petrobras default, but certainly anything smaller or less established could be a concern. Worse, we may be seeing the cycle turn against those emerging darlings - the BRICS - who only last year continued to be the place to put your money for the long run, in the considered opinion of so many. If a longer-term cycle of slow growth and even recession takes hold - as it already has in some countries - the bonds of these countries will be a nightmare for anyone who had thought they had a ticket to "income heaven" for the next 5 - 10 years.
Putting that to the side, we came across an article you may want to check out on Bloomberg that takes us through some of the simmering troubles in the BRICS and their little sisters. You see, as these emerging countries and companies face refinancing their existing debt in the next year or so, they're facing having to do so at much higher rates, never a good thing for a debtor who needs to refinance. It's like people who have adjustable mortgages on their homes initially financed at 2% fining out their new rate next year will be 3%. That's a 50% increase in their monthly payment. The same applies to countries and companies:
A surge in interest rates and the worst currency rout since 2008 in developing nations from Russia to Brazil are inflating corporate borrowing costs as $1.5 trillion of obligations come due by the end of 2015.Surge in interest rates? So maybe now's the much better time to invest in these bonds. After all, they'll pay you even more than they would have last year or the year before. (Will that client call us again looking for emerging bonds now that rates are up?) But read that last sentence we quoted from the Bloomberg article, especially the part about "as profit margins narrow." Do you really want to invest in companies with narrowing profit margins in emerging markets, some or all of which will experience slowing growth and perhaps even slip into recession - if they haven't already.? Are you sure they'll pay you your interest, even some of the bigger companies, in such circumstances? Is it worth taking on that sort of risk for a percent or two more interest?
Companies in the MSCI Emerging-Market Index (EEM) are facing the highest debt loads since 2009 as profit margins narrow to the least in four years, according to data compiled by Bloomberg.
Well, at least there's one money manager who thinks we shouldn't worry too much. Considering the scenario of companies having to refinance at higher interest rates - which is what's now looming in the coming year - our intrepid money manager shrugs it all off:
“Higher refinancing cost alone is usually not sufficient to cause a ‘meltdown’,” Zsolt Papp, a money manager who helps oversee $2.6 billion of emerging-market debt at Union Bancaire Privee in Zurich, said in an e-mail on Feb. 21. “It would have to be coupled with a collapse in the economy and no access to credit, basically a 2008-2009 scenario. And that looks not likely.”Now who is this fellow Papp? He manages money for one of the world's top private banking wealth managers. And his specialty is emerging market bonds. There's a lesson for us somewhere, don't you think? It's that anyone who manages money really can't give us much of value when it comes to evaluations of markets or asset classes, most especially when they're commenting on the asset class they themselves manage. In fact, there is strong evidence that right now most private companies in China, for example, basically have no access to credit - at least credit offered at something below "mafia" rates. And that's been the case for over two years now - with little reporting on this coming from the western media.
So here's where your reason and common sense will help you:
You might think that someone who manages emerging bonds full-time should have a certain expertise in the area that you and I might not have. But think about it. Could this guy ever say that investing in his bonds is far too risky for most of us? Can he afford to say that, since he's most likely compensated based on the amount of bonds he manages? Can you see the conflict of interest here, and do you understand why we never take the advice of such people? Use your common sense here, and you'll most likely agree that a money manager who manages one asset class may be the worst source for understanding either what's going on in the markets, or what may happen in the future.
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