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Emerging market debt: The search for alpha

As summer draws to a close, bankers and investors are gearing up for the rush of new bond issues that traditionally hits the market in the last quarter. In the emerging markets it’s little different. The pipeline of deals out of Russia is strong, Asia is witnessing one of its busiest times of the year and Latin American issuance should pick up now that Brazil’s election is out of the way. Even in the Middle East, corporates are beginning to appreciate the benefits of the capital markets.

Investors turn to illiquid securities in emerging markets.

And as many analysts point out, even with this plethora of deals demand far outstrips supply; global portfolio investors, hedge funds and dedicated accounts are all clamouring to get their hands on emerging market debt. A three-year rally and solid long-term prospects – credit quality remains strong – mean that investment inflows are still sizeable.

This demand/supply imbalance is pushing spreads ever tighter. Although this is causing some analysts to ponder how much further prices can rise, it is also beginning to have an impact on the nature of emerging markets investing. Increasingly, for some investors it’s no longer enough to invest in plain vanilla emerging markets instruments. The returns are simply insufficient.

Attention is instead focusing on less obvious securities, according to Walter Molano of BCP Securities, in an attempt to reduce beta and, in turn, to gain alpha. Investors are eschewing liquid securities, he reckons, in favour of illiquid instruments with strong credit stories. Private placements, loans, structured credit and short-term debentures are all on their radar screens. As Molano points out, this is placing a lot more emphasis on credit analysis, with the price discovery process becoming more difficult.

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