Emerging markets are back. That’s the conclusion of the latest quarterly debt survey by Emta, formerly the Emerging Markets Traders Association. In the second quarter of 2003, total emerging-market debt trading passed $1 trillion for the first time in five years.
Trading volumes peaked at $1.62 trillion in the first quarter of 1997 but were devastated by the series of crises that started in Asia later that year and seemed to continue until the Brazilian presidential election at the end of 2002. But emerging markets have been getting attractive since then, with investors that had been sniffing at the asset class for a while finally deciding that the returns are worth the risk. “This is money that has committed itself to the asset class for some time,” says the head of emerging-market trading at one New York bank. “They did their due diligence: it’s not fast money.”
History lesson
Still, with volumes approaching those of the fluffiest days, there’s always the worry that history might repeat itself. “The prolonged rally earlier this year encouraged greater participation from tactical asset allocators and momentum investors,” says Jonathan Bayliss, head of quantitative strategy at JPMorgan in London. Many of those investors were already leaving the asset class in May and June, when volatility picked up: their exit added not only to volatility but also to the volume figures.
At the same time, volumes in derivatives, while still small compared with total trades in the cash market, are soaring. Non-deliverable forward volumes increased by 84% in the second quarter to $320 billion, while credit default swap volumes surged by 111% to $49 billion.
The derivatives figures speak more to the newfound sophistication of the asset class than they do to its riskiness. Credit default swaps are increasingly being used as fixed-income instruments in their own right: at many fund managers and all investment banks, for instance, they are plotted on yield curves alongside global and Brady bonds.
And volumes today are much less leveraged than those of five years ago. While a lot of small emerging-market hedge funds have recently entered the market and are using leverage, it’s on nothing like the kind of scale that was seen in the heyday of Long-Term Capital Management – the fund that was capsized by Russia’s debt default.
What’s interesting is the way in which the total size of the asset class – as measured by the face value of all the outstanding bonds – hasn’t remotely kept up with the inflow of funds. Bond prices have surged as a result, giving the asset class outsize returns, but countries have – so far, at least – kept to their hard-earned fiscal prudence, and aren’t borrowing just because they can. It’s a virtuous circle of low issuance catalyzing greater inflows, higher volumes, and higher prices. The only question is how much longer it can go on?
