Another good year for emerging market bonds

In the face of numerous challenges in the global economy, such as rising US interest rates, high energy prices, hurricanes and defaults, emerging market bonds have once more delivered a strong performance in terms of total returns to investors and were among the best performing asset classes for 2005.

The Bear Stearns Index of Central American and Caribbean countries (BSCAX) posted a return of 11.7 percent in the calendar year 2005. BSCAX is used to track the total return performance (that is, interest and price appreciation) of 40 debt instruments that are traded on the international capital market and issued by 11 countries in the Caribbean and Central American region including Jamaica.

The BSCAX surpassed the returns on our local US dollar fixed income instruments including mutual funds and also outperformed all major fixed income credit indices including JP Morgan’s EMBI Global (9.8 percent), which tracks the larger credits of Emerging Europe, Latin America, Asia, the Middle East and Africa and Merrill Lynch’s US Corporate Index (8.3 percent), which tracks the debt issued by all US corporations.

The BSCAX showed that the higher yielding, lower rated credits outperformed the market. The top three performers were the Dominican Republic (18.6 percent) Belize (15.8 percent) and Jamaica (14.2 percent).

The bullish mood in Jamaican bonds has carried through into the New Year as bond prices continue to rally with most issues including the most recent 20-year bond, trading at record highs. The trend is expected to continue as the stock market sleeps and investors search for attractive investment options. Although we can expect periods of volatility owing to such factors as poor fiscal results, unforeseen shocks such as hurricanes and possibly stormy public sector wage negotiations.

The report also revealed that the strong double B credits registered returns roughly in line with the Index with Costa Rica (12.3 percent) on the high end of the range and El Salvador (9.8 percent) at the lower end. Moving higher up the credit curve, Trinidad and Tobago and Barbados showed returns of six percent compared to just over two percent on most deposit accounts in Jamaica.

Generally, the international marketplace has been supportive of EMCs and many governments in the Latin American and Central American region have seized the opportunity to do some housekeeping to minimise their debt-related vulnerabilities by financing forthcoming debt payments ahead of time, lengthening maturities — as was the case in Panama and Peru — and/or reducing the portion of US$ denominated debt.

The year saw Brazil issuing its first local currency global bond; Colombia retiring over US$2 billion of its foreign currency debt; Brazil and Russia deploying part of their robust reserves to prepay external debt; market-friendly debt restructuring in Grenada; debt exchanges in Argentina and the Dominican Republic and Jamaica accessing funds on the international capital market at a lower cost of capital than in previous years.

Given the favourable financial conditions it is not surprising therefore that the number of sovereign upgrades has exceeded downgrades by a ratio of 3:1 and is consistent with EMCs migration up the credit curve as spreads (i e yield premium over US Treasuries) have continued to contract.

The JP Morgan EMBI Global showed a reduction in spreads to a record low of 233 basis points, relative to 347 at the end of 2004. What this means, however, is that the EMCs with tighter spreads should become more sensitive to US interest rates.

Although EMCs as an asset class have performed well as a whole, investors should be mindful that countries with weak fundamentals such as high debt ratios, weak current accounts or fiscal positions tend to be more volatile and unless there is strong local demand could face a liquidity crunch and possibly an accompanying rise in risk aversion.

(Jamaica Observer)

Mildred Moss is chief operating officer of Sterling Asset Management Limited.