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Diversity-hunters get more emerging debt choice
September 5, 2012 / 1:05 PM / 5 years ago

Diversity-hunters get more emerging debt choice

LONDON, Sept 5 (Reuters) - International investors who have long complained of limited choice in emerging market assets are now finding that local currency debt markets from Nigeria to China are becoming more accessible.

The local debt of South Africa and Nigeria is expected next month to enter indices tracked by global and emerging market debt investors, making it available to a wider pool of buyers, while Russia and China are opening up their local debt markets to foreign investors.

Foreign holdings of local government bonds have nearly tripled in Mexico and nearly doubled in South Africa since 2007, according to JP Morgan, and these index and regulatory changes are likely to increase foreign holdings further.

Core debt markets in the euro zone, United States and Japan are offering tiny or even negative yields, helping emerging market bond funds to post net inflows of $30 billion this year, according to Boston-based fund tracker EPFR.

South Africa will join Citi’s World Government Bond Index, benchmarked by $2 trillion in international funds, in October, when Nigeria is expected to join JP Morgan’s local emerging GBI-EM series, benchmarked by around $170 billion of assets.

“There is clear demand to own these assets, for diversification and for the potential to pick up higher yields,” said Luis Costa, emerging markets strategist at Citi.

“Nigerian T-bills trade at 14 percent, that’s a fantastic pick-up in rates over the core.”

Citi estimates up to $7.5 billion will flow to South Africa’s bond market over the next couple of years due to its inclusion in the WGBI index, whose 23 existing countries include emerging markets Mexico, Malaysia and Poland.

Increased demand for a bond market lowers bond yields, reducing borrowing costs for the issuer.

South African three-year debt yields have fallen more than 100 bps since the WGBI announcement in April, though the central bank’s sharp rate cut in July also helped. Nigerian three-year bond yields have fallen to three-month lows since the JP Morgan announcement last month.

RUSSIA, CHINA

While South Africa and Nigeria’s membership of the bond market pack reflect improved credit ratings or liquidity, countries with more capital controls are also aware of the need to attract international investors.

Russia is expanding foreign participation in its $90 billion OFZ market by allowing it to be cleared via the international Euroclear and Clearstream systems. This means investors no longer need a local account in Russia to buy local debt.

Foreign ownership of Russian local debt is estimated at only around 5 percent of the market, compared with 30 percent in Poland and Mexico and 50 percent in Hungary.

Even in China, which has been reluctant to open up its onshore markets too fast, international investors can now buy domestic bonds through the country’s Qualified Foreign Institutional Investor (QFII) system of licenses and quotas, which Beijing loosened further in July.

Central banks and sovereign wealth funds are enthusiastic buyers of Chinese bonds.

DRAWBACKS

Investors say that in global GDP terms, emerging markets merit a larger weighting in portfolios, but there is still a lack of suitable assets. In index terms, weightings are just 0.41 percent for South Africa in the WGBI and 0.59 percent in the GBI-EM Global Diversified index for Nigeria.

And some investors are constrained from investing until markets enter a benchmark index, a lengthy process that can allow specialist investors to get ahead of the game.

The wild performance of currencies this year could also deter investors, who have so far preferred emerging debt denominated in dollars or euros, according to EPFR data.

The South African rand has fallen more than 4 percent in 2012 and even China’s yuan, for years viewed as certain to appreciate, has weakened.

Emerging local currency debt has posted returns of more than 9 percent this year, but it is outstripped by hard currency returns of 13 percent.

“When we have a turbulent period, the local debt sells off more ... the volatility of local debt has disturbed more clients,” said Sam Finkelstein, emerging market debt portfolio manager at Goldman Sachs Asset Management.

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