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Skip Navigation LinksHome :: Back Issues :: Latin debt is a safe haven for investors

March 2002

Latin debt is a safe haven for investors


With worries about US corporate credit scaring bond market investors far more than Argentina’s default, emerging-market issues have retained their popularity. Emerging-market debt offers low volatility, rising prices and decent volumes. Latin issuers remain in the vanguard. The only problem is that their bonds are beginning to look expensive.




       
Have bond investors already plucked the sweetest fruit
in Latin American markets?
Emerging sovereign debt markets in general, and Latin American sovereign bonds in particular, had a surprisingly good year in 2001, considering that the largest sovereign bond issuer of all time defaulted on some $100 billion of global bonds. The Argentine default was very clearly flagged, allowing virtually all professional bond investors to exit the country in good time.
At the same time, investors in US corporate debt, from Enron to WorldCom, were starting to get jittery about their own market. The parallel waves of selling - in Argentina and in US corporate debt - left bond investors sitting on far more cash than they would normally be comfortable with.
Meanwhile, emerging-market debt markets were looking healthy. Pick any bond-issuing country in the world: chances are, if it isn't Argentina, it returned more than 10% in 2001. And the returns weren't at the expense of market risk, either: volatility in JPMorgan's EMBI+ emerging-market bond index has now declined to just 3.6%, its lowest level since 1995. That's below the normal level of 10-year US treasuries, and compares with treasury volatility levels closer to 10% at the moment.
Low volatility, however, does not mean low volumes - quite the opposite. Even with the slump in Argentine debt trading, total volume in emerging-market debt rose 22% in 2001, to a total of $3.5 trillion. It's now at its highest level since the Russia crisis of 1998, and the 2001 figure marks a 59% jump from the $2.2 trillion that was traded in 1999.
Part of the reason is that investing in emerging-market debt is much more difficult now than it used to be in the days when you just bought new issues from the big three - Argentina, Brazil and Mexico - and banked the coupons.
Chris Luth, head of new issues for emerging markets on Deutsche Bank's syndicate desk in New York, says: "This year, and last year, you really need to be a lot more focused and take concentrated bets."
Investors are also being asked to buy a much larger range of credits. There are many deals coming to market now from such countries as Costa Rica, El Salvador, Panama or the Dominican Republic. These bonds are illiquid, but they are in great demand all the same: an 8% yield on Costa Rican debt might be low, but it's still a lot higher than a 1.5% yield on overnight cash.
And there are other good reasons to continue to buy the asset class. Emerging-market sovereign debt in general is the one sector that has continued to show signs of improvement even as the rest of the world sees recession biting. Mohammed El-Erian, who runs the emerging-market portfolio of Pimco in California, says: "If you look at the ratings agencies over the past 12 months, you've had one negative announcement for every four positive announcements [in emerging markets], and the negative announcements have been dominated by Argentina. You've had a very clear improvement in average credit ratings. Compare that with corporates, where you've had one positive announcement for every three negative announcements."
The final - and long-awaited - feather in emerging markets' cap came on February 7, when Standard&Poor's finally gave Mexico an investment-grade credit rating. (It lagged well behind Moody's in this: Moody's had already upgraded Mexico from one investment-grade rating to a higher one earlier in the week.) Mexico is now on the radar screen of nearly every corporate bond investor in the US, to the point where it is becoming very difficult for dedicated emerging-market funds to justify investing in such a low-yielding country.
Getting too hot?
The question on everyone's lips now is how long this Goldilocks effect of rising prices, rising volume, and falling volatility can last. Cash-flush bond investors have been buying the likes of Panama and Mexico as something of a safe haven but in doing so they have bid up prices so much that emerging markets is now easily the most expensive asset class in the fixed-income world.
       

View graph.
One common comparison is between Mexico and WorldCom, the giant US telecommunications company. It has been having difficulties of late: its shares have dropped from $60 at the end of 1999 to as low as $6 this year. But it's consistently profitable, its credit rating is two notches above Mexico's even after Mexico's recent upgrades, and it throws off $15 billion in Ebitda a year. WorldCom's 10-year bonds are trading at 350 basis points over treasuries, about 100bp wide of Mexico. At one point, they were trading as wide as 450bp over treasuries.
If and when the panic in WorldCom bonds ends, they will be sufficiently cheap for investors to be able to wait for them to tighten in, buy them, and still hope to make a tidy profit. A syndicate head says: "One of the things we've heard increasingly from crossover investors over the past few weeks is that when it quietens down, they reckon that high grade is going to offer better relative value than emerging markets. You could buy WorldCom at 300bp over treasuries and have a reasonable chance it's going to go back to 200bp over. You're certainly not going to buy Mexico at 250bp over and expect it to get to 150bp over."
There's no doubt that emerging-market debt has performed well in the wake of the devastating Russian crisis of 1998. Spreads gapped out so much then that buyers have been rewarded not only with very high yields but also with enormous capital appreciation on their bonds. But emerging-market bonds aren't cheaper than similarly-rated high-yield bonds any more. In fact, they aren't even cheaper than many high-grade bonds. The low-hanging fruit has been plucked, and it's hard to see where further gains might be achievable.
Back to US high yield?
"Something is out of kilter," says Arturo Porzecanski, head of emerging-markets economics and debt strategy at ABN Amro. "Why buy emerging markets in the belief that the US recovery is around the corner when the effect of a US recovery on emerging markets will be of a trickle-down kind, when you can buy US high yield and get it up front? US high yield looks better to us than emerging markets."
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