Dispelling myths in frontier bond markets

What is preventing you from investing in frontier market bonds?  As investors scan the globe for opportunity, there are few areas that offer as compelling a mix of high growth prospects and rapidly improving fundamentals as the frontier economies.

Opinion

Web Share

What is preventing you from investing in frontier market bonds?  As investors scan the globe for opportunity, there are few areas that offer as compelling a mix of high growth prospects and rapidly improving fundamentals as the frontier economies.

By L. Bryan Carter

What is preventing you from investing in frontier market bonds?  As investors scan the globe for opportunity, there are few areas that offer as compelling a mix of high growth prospects and rapidly improving fundamentals as the frontier economies.

Yet these markets are typically underrepresented in asset allocation programmes, if not entirely absent. Ask why, and you often hear objections that don’t correspond to the current reality.

Let’s address these myths head on.

Frontier bond markets are too small for most bond managers or investors.  They are larger than many investors realise.  The universe of frontier debt outstanding has seen rapid expansion in both local and hard currency forms.  Nearly every country issues bonds, and frontier debt markets are expanding quickly as economic fundamentals improve. Over the past decade, the total frontier dollar-denominated market cap has ballooned from approximately $20bn to over $75bn, comprising a growing share of the total global dollar debt market capitalisation.

Frontier countries lack economic environments that support local bond markets.  In the 1990s, most emerging markets undertook key reforms that included floating exchange rates, independent central banks, and inflation targeting.  With central bank independence, inflation and interest rates tend to decline in turn.  As inflationary pressures ease and economic growth attracts foreign capital flows, a country’s currency can support a more open regime that allows the potential for currency appreciation.  This in turn provides a fertile ground for bond market investors.

Frontier bond markets only exist in dollar-denominated form.  A country’s macro-economic strength allows for yields that reflect true market risk.  Frontier markets generally offer higher yields in local currency debt relative to hard currency debt, in part to compensate for exchange rate uncertainty.  While local debt can be attractive even before dollar bond issuance, local frontier bonds may still have significant yield compression ahead of them after opening up to foreigners.

Over the past decade, emerging market local debt issuance has taken off, fast outpacing growth in emerging markets’ dollar denominated bond issuance. The stock of local currency emerging market debt outstanding is now at several multiples the size of the hard currency market. Similarly, in recent years frontier issuance has grown steadily for countries that have implemented the changes that investors want to see.

Frontier bond markets are illiquid and hard to trade.  Frontier market bonds are not necessarily illiquid, depending on the investor’s approach.  In order to access local bond markets, the key ingredient is identifying a counterparty for each country with access on the ground.  With custodial relationships in local bond markets, it is possible to trade and settle frontier bonds locally, minimising transactions costs and lowering counterparty risks.

The IMF has pushed for the creation of secondary bond markets in its programme countries, a measure often made part of IMF structural conditionality in frontier country loans. The IMF has also encouraged the initiation of ‘market makers’ programmes and active local exchanges to help increase local bond liquidity and extend yield curves to longer tenors. Using transactions costs as a measure of liquidity, there are relatively easy trading opportunities across frontier market countries.

We believe smart investors will not allow these misconceptions to deter serious consideration of frontier debt.   The current degree of underinvestment has resulted in a high yield premium for frontier securities.  Frontier bonds are not just for small specialised investors.  They are available to all, and the current opportunity is singularly attractive.

 

L. Bryan Carter is senior vice president and portfolio manager at Acadian Asset Management

Comments

More Articles

Subscribe

Subscribe to Our Newsletter and Magazine

Sign up to the portfolio institutional newsletter to receive a weekly update with our latest features, interviews, ESG content, opinion, roundtables and event invites. Institutional investors also qualify for a free-of-charge magazine subscription.

×