April 13, 2017 / 1:31 PM / 3 months ago

Euro, sterling bonds lure emerging debt funds with juicier yields

6 Min Read

    * Euro-denominated issuance volumes double since 2007
    * European institutional investors driving demand
    * LatAm euro issues trade wider than dollar counterparts

    By Claire Milhench
    LONDON, April 13 (Reuters) - Peruvian and Indonesian
euro-denominated bonds and Mexican sterling issues are just some
of the more esoteric hard-currency issues attracting fund
managers with their juicier yields compared with plain-vanilla
emerging dollar bonds.
    Once shunned by managers as too illiquid, the steady growth
in issuance volumes of such bonds, particularly in euros, has
led to a viable market. 
    Outstanding volumes of euro-denominated emerging market
bonds stood at $72 billion last year, up from about $37 billion
in 2007, ThomsonReuters data show, though their share of the
overall market is steady at around 13 to 16 percent (see table).
    Issue sizes have grown, as well. In February, the Mexican
oil company Pemex set a record for the biggest-ever
euro-denominated emerging market issue, raising 4.25 billion
euros.
    And because they are excluded from the most widely used 
emerging market benchmarks, such as JPMorgan's EMBIG for dollar 
bonds, they often trade at higher yields than their dollar
equivalents, offering fund managers extra bang for their buck. 
    "You used to see 300 million euros issued, and now it's half
a billion," said Alejandro Arevalo, an emerging market bond fund
manager at Jupiter Asset Management. "From a liquidity side it
has improved. It's more attractive as I am less concerned about
whether I can get out of the bond if I need to sell it." 
    Demand for euro issuance has been underpinned by European
insurers and pension funds, which need higher yields to meet
future payments to policyholders. Arevalo refers to
such investors as "sticky hands" because they tend to buy and
hold. 
    "If there is a panic in the market, people tend to sell the
benchmark securities first," said Wouter van Overfelt, a senior
portfolio manager at Vontobel Asset Management. "So some of
these dollar-denominated securities will sell off whereas the
euro-denominated securities won't necessarily move as much."
    He cited the example of Pemex, where big losses and poor
sentiment in late 2015 sharply pushed up yields on its 2024
dollar bond but more or less spared the 2025 euro issue.
    
    YIELD PICK UP
    Due to European institutions' preference for local names,
Latin American euro- or sterling-denominated bonds can trade at
much wider yield spreads - several managers cited the pick-up
offered by the Mexico's 2114 "century bond" denominated in
sterling over its dollar equivalent.
    Similarly, the 2025 and 2022 euro issues from Petrobras and
Mexican cement firm Cemex respectively offer a yield pick up
over their dollar equivalents of 40 to 90 basis points.      
    Tina Vandersteel, the head of GMO's emerging country debt
team, was among those who bought Mexico's century dollar bond
when it was issued in 2010. But she rotated out of it and into
the 2114 sterling issue when sterling assets sold off before
last June's Brexit vote in Britain.
    As a predominantly institutional manager, GMO doesn't have a
lot of in and out flows, she said.
    The trade also suits managers who are benchmark-agnostic,
like van Overfelt, who currently has about 35 to 40 percent of
his fund in non-dollar hard currency debt.
    "We see a lot of opportunities there today," he said, citing
Indonesia's 2028 euro issue, which pays almost 50 percent more
in spread terms versus the dollar equivalent. His largest
overweight, Mexico, is expressed through the century bonds and
Pemex euro bonds. 
    Bryan Carter, head of emerging market fixed income at BNP
Paribas Investment Partners, also cites a Peruvian 2026 euro
bond that offers a 30-basis-point yield pick up relative to its
nearest dollar equivalent. 
    "If you can find them, they can be very interesting at those
valuations – they are cheap because no one even remembers they
exist," Carter said. 
    Euro debt supply has remained steady, with over $26 billion
raised in the first quarter, TR data shows. About 9 percent of
outstanding emerging market corporate debt is now denominated in
euros, according to JPMorgan, but that rises to 21 percent for
emerging Europe. 
    However, euro or sterling will not displace the dollar's
hegemony in emerging bond markets. First, most dollar bonds are
eligible for the JPMorgan's EMBI Global or CEMBI indexes tracked
by funds managing hundreds of billions of dollars. 
    Second, euro-based investors tend to favour investment-
grade, frequent issuers, so junk-rated or debut issuers from
Africa, for instance, may not find takers.
    Finally, the euro's increased market share may have come at
the expense of other currencies - the yen, for instance, saw its
share dwindle last year to 1.1 percent of bond sales versus 2.6
percent in 2007. That has reduced liquidity.
    "Unless there are other investors looking at the same thing
and unless there's liquidity, you won't get the repricing,"
Carter said.
    
    EMERGING MARKET YEARLY ISSUANCE VOLUMES - 2007
 CURRENCY       PROCEEDS    MARKET SHARE   NO. OF ISSUES
                (US$ MLN)                  
 US Dollar      145,320.2   63.7           350
 Euro           36,787.9    16.1           70
 British Pound  8,671.4     3.8            14
 Japanese Yen   6,000.8     2.6            29
 Swiss Franc    2,965.8     1.3            9
                                           
    EMERGING MARKET YEARLY ISSUANCE VOLUMES - 2016 
 CURRENCY       PROCEEDS    MARKET SHARE    NO. OF ISSUES
                (US$ MLN)                   
 US Dollar      408,137.2   77.3            628
 Euro           71,891.5    13.6            89
 Chinese Yuan   17,549      3.3             54
 British Pound  6,882.5     1.3             7
 Japanese Yen   5,654.9     1.1             26
 Swiss Franc    3,716.4     0.7             14
 Source: ThomsonReuters

 (Reporting by Claire Milhench, editing by Larry King)
  

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