Junk Bondholders Weigh Emerging-Market Exit From Benchmark

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Bank of America Corp. will decide this week whether to remove emerging-market companies from its $2.2 trillion global high-yield index.

The lender asked junk-bond investors to vote on the matter as part of an annual review of its benchmarks after a slew of downgrades to Brazilian and Russian companies boosted their share of the index. Bank of America said it will implement any changes at the end of September.

The decision pits investors who want the measure to better reflect the corporate high-yield market against those seeking higher yields associated with extra political risk. A removal of emerging-market companies, which accounted for 18 percent of the index at the end of March, may trigger price swings if bondholders are forced to sell those securities and raise funding costs for excluded companies.

“It may be detrimental if emerging-market companies were removed from the index because this could narrow the investor base,” said Ulrich Gerhard, a London-based fund manager at Insight Investment Management, which oversees about 397 billion pounds ($619 billion) of assets. “Once we see the outcome of the review we’ll decide whether we change the benchmark for the fund or if we need to change guidelines in terms of taking non-index positions.”

Petrobras Downgrade

The portion of emerging-market companies in Bank of America Merrill Lynch’s Global High Yield Index has swelled since they were first included four years ago.

Petroleo Brasileiro SA became the biggest index member after the Brazilian oil producer was cut to junk by Moody’s Investors Service in February, with $44 billion of debt, according to Bank of America. Russian companies represent the largest emerging-market nation at 4.4 percent, followed by Brazil at 3.8 percent. U.S. companies make up 52 percent.

Bank of America is considering removing emerging-market companies from sub-indexes such as the euro high-yield index, even if it keeps them in the global benchmark.

“It can be tricky when you have an index that suddenly has a big weight from countries like Brazil and Russia,” said Roman Gaiser, who oversees 3.5 billion euros ($3.9 billion) of assets as the Geneva-based head of high yield at Pictet Asset Management SA. “In those countries, the sovereign risk overwhelmingly dominates the corporate risk.”

Borrower Premium

Exclusion from the index may reduce demand for emerging-market corporate bonds, making it harder for companies to sell securities in international markets and for investors to get returns, according to Mitch Reznick, co-head of credit at Hermes Investment Management, which oversees $44.5 billion.

“Our clients have shown a clear desire to be invested in global high-yield debt,” because it provides diversification and flexibility, said Reznick. “We will continue to deliver it to them even if the index is changed.”

Bank of America’s global benchmark returned 2.4 percent this year, compared with 1 percent for the U.S. index, which doesn’t include emerging-market borrowers.

“The change would make my job harder but it wouldn’t stop me from buying emerging-market corporate bonds,” said Azhar Hussain, head of global high yield at Royal London Asset Management Ltd., which oversees about 86 billion pounds.

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