Photographer: Dado Galdieri/Bloomberg

About All That Money That's Been Flowing into Emerging Market Debt...

It's going to the big boys, according to Citi analysts.

The recent rally in emerging market bonds has been pretty good, but it could also be beta.

Analysts at Citigroup Inc. point out that the recent surge in the price of bonds sold by companies in emerging markets has not been uniform, with more money gushing into securities sold by corporate issuers that have a history of selling large amounts of debt, as opposed to smaller issuers with less debt outstanding.

"We find that by segmenting the market based on size of corporate issuance, we detect an interesting truth of the recent EM corporate debt rally: It is mainly centered on the large benchmark credits," write analysts W.R. Eric Ollom and Ayoti Mittra. "Intuitively, this makes a lot of sense. The larger issuers will tend to be more liquid, better known, and would be the first to snap back when investors return."

Smaller debt issuers could therefore be the "the canary in the coalmine," Citi adds, when it comes to gauging the true strength of a rally that now sees junk-rated EM debt trading at tighter spreads than U.S. high-yield bonds.

"A flagging 'small' money rally will show us that rally is losing steam, while a sustained bid for the small credits would imply the rally has more legs," the analysts write.

Source: Bloomberg/Deutsche Bank

Money flows into emerging market corporate bonds have largely gone into the biggest issuers, including Brazil's junk-rated, debt-ridden state-owned oil producer, Petroleo Brasileiro S.A. Yields on Petrobras's $1.6 billion of bonds due in March 2017 have plunged almost six percentage points, for example, thanks in part to a surge in Brazil's currency. Bonds sold by large debt issuers may be more attractive to investors given they are usually included in benchmark indexes, Citi adds.

Meanwhile, smaller issuers have failed to catch a greater portion of the money flows. "It’s still mostly beta," Citi notes, meaning that such bonds are simply moving in tandem with the wider rally in emerging market credit.

"These credits will not be as well covered by the market, nor as actively traded," the analysts add. "Their pricing will tend to be a reflection of trading levels of the 'hot' money, subject to a risk premium ... EM tourists rarely traffic in this paper."

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