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Capital Markets

Bond markets: Local-currency opportunities

While credit is one source of alpha for emerging markets investors, another is local currencies and bonds. For mainstream emerging markets funds, moreover, investing in local-currency securities is easier and, arguably, more sensible than taking exposure in credit instruments, where liquidity is at premium.

Investors bet on emerging market alpha

As external debt markets are shrinking, local-currency bond markets are growing. This is partly being driven by bond exchanges as sovereign borrowers reduce their external debt for local-currency issues. Rapid development of domestic pension funds and other local investor bases is also acting as a spur. Another big influence is “soaring demand from foreign investors,” according to Mike Conelius, emerging markets portfolio manager at T Rowe Price. Many of these buyers are long-term institutional investors, such as pension funds and insurers. “According to the IMF,” adds Conelius, “institutional investors have moved as much as 10% of their emerging market exposure into emerging market local-currency instruments compared with minimal exposure three years ago.” Certain governments are actively encouraging foreign investment flows into their local bond markets. Brazil’s government, for example, announced in February the elimination of a 15% withholding tax levied on income from local public bonds by non-residents. If funds cannot invest directly in a local market they can do so through a variety of synthetic instruments, such as CLNs, total-return swaps and promissory notes.

For international investors local currencies and bonds can be a profitable trade.

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