Sunday, Aug 28, 2016

Dubai:

With a likely September rate raise hanging over the financial world, many bond fund managers are looking overseas to boost their return — and that is good news for emerging markets. At least for now.

The major developed economies are trying to give their countries a boost by keeping interest rates at record lows, and in the case of the European Central Bank and Bank of Japan, interest rates are actually gone negative, putting investors in the unusual position of having to pay extra for risk-free securities (government-backed bonds).

But emerging markets offer something that most investors can’t find. Those markets are filled with companies — and in some case governments — that are desperate to raise cash to fund growth or fill gaps in their budgets. Investments in emerging market bonds reached an all-time high in the week through July 20 to $4.9 billion (Dh17.98 billion), according to Bank of America. And at the same time, US bonds are being rapidly sold off. Overseas investors sold $32.9 billion in US government bonds in June after selling $18.29 billion in May. That followed record funds out of US bonds of $74.6 billion in April.

“Emerging markets are benefitting from multiple of factors. The interest rates are coming lower. There’s also an inflow of new capital coming in emerging market debt, the environment for EM bonds is constructive and it may continue to do well,” said Anita Yadav, head of fixed income, Emirates NBD, which she says has triggered investments into EM debt.

Traditionally, interest rates and bond prices have been inversely proportional, meaning lower interest rates would tend to boost bond prices. That’s only happening in emerging markets.

“We see a room for EM central banks to also lower interest rates. Across all major emerging market economies, we have high interest rates, and its set in the backdrop where inflation is well behaved in the in most countries, and we expect inflation to be lower,” Maya Bhandari, Director, Multi Asset Allocation, Columbia Threadneedle Investments told Gulf News. Columbia Threadneedle Investments likes emerging market local currency debt, including Mexican bonds among others.

Developed markets bond were rallying as late as last year, but then the Fed raised interest rates for the first time in nearly a decade last December.

The “bonds rally started off with the great financial crisis, and the policy response, following easing monetary policy from the US Federal Reserve, among others. The combination of very easy money policy and very less inflation created perfect condition for bond markets. We are not of the view that the rally in bonds would continue for long. The current trend won’t last over the medium term,” Bhandari said.

Record issues

GCC bonds too are also not being left behind. The GCC bond market is expected to see a record year.

“On the supply side, more bonds should hit the market. In the next five years, the bond market should really develop, given the tightening liquidity of the banks, although issuers might have to offer wider spreads. We expect banks to increasingly tap the debt markets to diversify their funding base and should be the biggest issuers,” Jaap Meijer, Managing Director and head of research at Arqaam Capital said.

In the first half of the year, GCC governments and corporates have issued $30 billion, and “we expect another $20-30 billion in the rest of the year, so the issuance could easily cross $50 billion and that would be the highest ever,” according to Anita Yadav from Emirates NBD.

“We expect the issuance to remain at high levels and increase further in the second half, because there are budget deficits that government need to fund,” Yadav said.

The trend of the new issuances is likely to stay on expectations that rates will stay lower for longer. With expectations of a slower rise in rate by the US Federal Reserve, companies are expected the maximum use of the low interest rate environment to fund growth. “The cost of borrowing is low, corporates and governments may incentivise to raise money now. Which means issuances would be higher,” said Yadav.

Box

How are debt instruments (bonds) different from equity (stocks)?

* Issue equity allows a company to raise funds without incurring debt. A bond has to be paid back with interest, which is why they are often referred to as “debt.”

* Those who purchase equity (stocks) gain ownership in the issuing company, giving them a right to vote in company matters. Bonds do not give the bearer any “ownership” in the company.

* Stocks prices vary given the public perception of the company, and over time, changes in the value of the stock are unlimited. A exceptional performance in a equity can also trigger a dividend payment.

* The value of a bond is stagnant and pays off at fixed amount with a fixed interest rate at maturity, which can range between a few years up to 50 years. The exception to this rule is coupon payments, which are periodic payments over the life of the bond. Coupons are generally offered as a financial incentive to investors.

By Siddesh Suresh Mayenkar Senior Reporter

Gulf News 2016. All rights reserved.