Debt owed by some of the world’s riskiest countries is expected to provide emerging market investors with a hedge against potential turmoil from the upcoming U.S. election.
Bloomberg reported that managers of a number of funds and investment companies are resorting to diversifying their portfolios by investing in frontier market government bonds (smaller markets that are less vulnerable to external shocks) with high returns.
These markets are described as being less vulnerable to geopolitical shifts and changes in US policies, compared to countries with better investment ratings.
Strong returns
In a year marked by heightened geopolitical tensions, frontier market dollar bonds returned nearly 6%, more than five times the gains of their higher-quality emerging market peers.
“We think now is a very attractive time to look at emerging markets,” Yvette Babb, portfolio manager at William Blair, told Bloomberg.
Historical data supports this strategy. During Trump’s first term, frontier debt (debt that lacks sufficient collateral to be collected due to its low credit rating) yielded 30%, compared to about 21% for investment-grade emerging market bonds (bonds issued by countries with good credit ratings).
During Biden’s presidency, border debt has outperformed investment-grade bonds, generating positive returns of 3% versus a 10% decline in its less risky peers, according to data reviewed by the agency.
How does Trump affect?
With Trump making new and increased tariffs a key part of his agenda, the potential for market volatility looms.
“Higher yields on frontier debt would protect investors from price volatility,” Carmen Altenkirch, an analyst at Aviva Investors Global, told Bloomberg.
Countries with low credit ratings currently offer a premium of more than 500 basis points over US Treasuries, compared with about 100 basis points for emerging market bonds with good credit ratings.
Reforms boost emerging markets
Structural reforms undertaken by these countries, including currency devaluation and interest rate hikes, have strengthened their financial position and reduced default risks in their financial markets.
The number of countries with bonds trading at distressed levels has halved in the past year. Despite the optimism, risks remain. Last year, Bolivian bonds lost about a third of their value, and Ecuador and Belarus also suffered significant losses, the agency says.
A second Trump term could be a “contradictory mix” for emerging economies, according to Yerlan Syzdikov, head of emerging markets at Amundi.
In contrast, he spoke of the potential benefits that a number of markets could reap from the fractured global economy and from the redirection of trade and capital flows.
Bloomberg notes that the possibility of a Trump presidency adds a layer of uncertainty that could keep borrowing costs high and weigh on currencies and lending costs for all emerging market issuers.
