Investors Fleeing Junk See Less Risk in Emerging-Market Debt

  • Deutsche Asset, Brandywine money managers making the switch
  • Developing-nation funds get $55 billion of inflows this year

Investors tired of the measly returns in junk bonds are shifting their money to emerging-market debt.

Funds are flowing into developing-nation assets as traders pulled cash from high-yield funds in recent weeks. Investors at Deutsche Asset Management and Brandywine Global Investment Management, who have more than $170 billion under management, say they are making the switch in pursuit of higher yields with less risk.

Investors around the world are looking for new places to put their money as suppressed borrowing costs in Europe, Japan and the U.S. push interest rates down to levels that would have been unimaginable a decade ago. Emerging-market debt is by no means cheap relative to historical norms, but it pays higher yields than other parts of the bond market and that’s what traders are looking for in an environment where returns are scarce, according to Christian Hille, Deutsche AM’s Frankfurt-based global head of multi asset.

“That’s a conclusion we reach in our asset-allocation meetings every week,” Hile said in an interview. “There are a number of countries in emerging markets which are much more attractive than expensively-priced investment-grade or high-yield credit.”

Investors pulled $616 million form high-yield bond funds in the week ending Sept. 13, a second week of outflows, Bank of America Merrill Lynch said, citing EPFR Global data. Over the same period, they added $1.7 billion to emerging-market funds.

The pullback comes as yields for the best-quality corporate junk bonds in Europe drop below those on U.S. Treasuries, setting off alarm bells for traders concerned they’re not being compensated for the risks of owning the debt. Toys ‘R’ Us Inc. shined a spotlight on what could go wrong this week when it became the latest in a recent line of more than a dozen retailers to file for bankruptcy.

Biggest European Junk Bond Fund Says Now Is Time to Be Fearful

Emerging markets not only offer higher average yields, but also exposure to economies such as Russia and Brazil where growth is returning after two years of recession. Local debt markets are becoming more alluring amid slowing inflation, relatively high interest rates and strengthening currencies in developing nations.

Holdings in active active funds that track emerging-market debt have risen 15 percent this year, according to EPFR. High-yield funds have added about $900 million, a 0.6 percent increase.

Regina Borromeo, the head of international high yield at Brandywine Global Investment Management in London, says the firm’s emerging-market holdings have swelled to the highest level since 2013 after it took profits on junk credit and bought Latin American bonds.

“We like certain Latin American emerging markets because at this point of their economic cycles, they are in recovery phase with attractive yields and currencies,” Borromeo said. “Parts of high yield are priced for perfection so that’s why we are cautious.”

Investors should be cautious on the rally in emerging markets because a rise in global interest rates will cause a selloff in all risk assets, Jeffrey Gundlach, the co-founder and chief executive officer of DoubleLine Capital LP, said last month. High foreign ownership of local-currency debt markets is setting them up for a hard landing if global monetary policy tightens, analysts at Deutsche Bank AG said this month.

The Federal Reserve said on Wednesday it will next month begin winding back an unprecedented bond-buying program that has pushed down borrowing costs. The central bank’s intention to press ahead with another rate hike this year and three more in 2018 caught some investors by surprise, sending bond yields and the dollar higher.

“We’re living in times which are pretty extraordinary in terms of central bank policy, so comparing current prices to history can be misleading,” Deutsche AM’s Hille said. “From a risk-reward perspective, you still get compensated in emerging markets and the prospects are better.”

— With assistance by Sid Verma

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