Debt from the world’s riskiest countries is seen as offering emerging market investors protection against U.S. election upheaval.
Asset managers at William Blair Investment Management and Amundi SA have diversified their portfolios in frontier market government bonds – higher-yielding debt from low-income developing countries such as Nigeria and Kazakhstan – which they say are less vulnerable to geopolitical shifts or U.S. policy shifts.
This contrasts with the risks faced by investment-grade countries such as Mexico, which could face significant headwinds from new trade barriers following the inauguration of President Donald Trump, and China, also a highly rated country, which could face a more hostile foreign policy environment and an intensification of trade restrictions imposed by Trump under President Joe Biden.
In a year marked by rising geopolitical tensions and a tumultuous election, frontier dollar-denominated bonds have returned nearly 6% so far, more than five times the gains of higher-rated emerging-market bonds. Investors say that could continue if a Trump victory leads to more volatility across markets.
“We think now is a very attractive time to look at frontier markets,” said Yvette Babb, a portfolio manager at William Blair & Co. “Frontier markets are driven by more idiosyncratic developments and are arguably less correlated to global sentiment.”
A second term for Trump would likely see riskier debt win out, repeating what happened during his first term.
Over the four years through January 2021, frontier bonds returned 30%, well ahead of the 21% return of investment-grade emerging market bonds. Frontier bonds have also outperformed under the Biden administration, returning 3% compared with a minus 10% return for riskier bonds.
During his recent campaign, President Trump has touted new or increased tariffs, including tariffs of up to 60% on Chinese goods, which could spur inflation and keep interest rates higher for longer, posing new risks to emerging market assets, according to Goldman Sachs Asset Management.
Frontier bonds’ high yields cushion investors against fluctuations in interest rates, said Carmen Altenkirch, an analyst at Aviva Investors Global Services in London.Currently, Frontier bonds and other junk-rated Treasuries are offering yields more than 500 basis points higher than Treasuries, compared with about 100 basis points for higher-quality emerging-market bonds, according to data compiled by Bloomberg.
“Emerging market debt, especially with longer duration investment grade bonds, has very little spread headroom,” Altenkirch said. “A lot will depend on what happens in longer-dated U.S. Treasuries, where fiscal concerns will dominate.”
Even before the potential impact of a Trump administration became clear, frontier-market local-currency bonds had been recommended by fund managers including JPMorgan Chase & Co. and Pacific Investment Management Co., who saw broad structural reforms, including currency devaluations and higher interest rates, as boosting returns.
The reforms also strengthened finances and reduced the risk of default: The number of countries whose sovereign bonds were trading at non-performing levels fell by half in the year since, according to data compiled by Bloomberg.
Despite the optimism, frontier bonds could still hurt investors the hardest if things turn for the worse: Bolivian government bonds lost about a third of their value last year, the worst losses among developing countries, followed by Ecuador and Belarus.
Yerlan Syzdikov, head of emerging markets at Amundi, said a second Trump administration would be “a mix of good and bad” for the periphery. While he said he was “interested” in countries like Vietnam, he said he was also considering Central Asian countries such as Kazakhstan, a major uranium producer.
In theory, all these countries “would benefit from the old-fashioned decoupling of the world economy and redirection of trade and capital flows,” Syzdikov said. “Some of this is true, some of it may not necessarily be true, because even a country like Vietnam could become a victim of a trade war if Trump becomes president.”
Emerging market bond issuance is expected to slow for the rest of the year, and the possibility of a Trump presidency could add further uncertainty and keep borrowing costs high.
Additionally, the risk of tightening U.S. monetary policy could boost the dollar, weighing on currencies and borrowing costs for all emerging market issuers, including frontier economies.
Still, the completion of debt restructurings in countries such as Zambia and Sri Lanka, and economic reforms in countries such as Egypt, have eased risk concerns.
Jetro Siikkinen, head of emerging markets revenue at $100 billion-asset LGT Capital Partners, said his firm has shifted to investing in Egyptian and Nigerian bonds after years on the sidelines. He said the firm’s insulation from global volatility should support bonds over the next 12 months to two years.
“What happens in Uruguay means nothing to Uganda, and what happens in Uganda doesn’t affect Uzbekistan,” Siikkinen said. “That helps me sleep well at night.”
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