Barclays Says Get Rid of Your Favorite Emerging-Market Bonds

Jun 06, 2014 12:33 pm ET

(Updates trading beginning in third paragraph.)

June 6 (Bloomberg) -- Barclays Plc says it’s time to change things up in your emerging-market bond portfolio.

Round up all those popular, investment-grade bonds that you feel safe holding in your portfolio -- names like Vale SA and Petroleos Mexicanos -- and sell them. They’ve become too expensive, Barclays says. In their place, load up on cheaper, yet still high-quality debt. These are lesser-known names such as KazMunayGas National Co. and Mexico Generadora de Energia S de RL.

Barclays’s argument is that the rebound that emerging markets have posted across all asset classes in the past four months has lured investors from the developed world mostly to the best-known bond names. Companies that are less familiar to investors in the U.S. and Europe haven’t rallied as much. Take the yield gap between Pemex and MexGen as an example. It has widened to 1.3 percentage points from 0.96 percentage point since January, according to data compiled by Bloomberg.

“It’s the credits that developed-market investors tend to buy which have done the best, and that trade has largely played out,” Barclays strategist Aziz Sunderji said in a June 4 telephone interview from New York. “The next trade is a rally in the bonds which have not historically enjoyed that same sponsorship.”

Limited Returns

Bargains will be harder to come by in the second part of the year as the spread between the most creditworthy emerging- market companies and their developed-country counterparts tightens after reaching the widest gap in more than two years in February.

Shifting out of the most liquid segments of the $1.2 trillion developing-nation company debt market will help asset managers offset a rise in U.S. Treasury yields that will limit average gains on emerging-market corporate debt to just 0.6 percent for the rest of the year, Sunderji said.

High-grade emerging-market corporate bonds pay an average 3.56 percent, or 0.67 percentage point more than their developed-nation peers. That’s down from 0.98 percentage point four months ago, while still above the five-year mean of 0.53 percentage point, Bank of America Corp. index data show.

“Some of the rally has been driven by crossover demand for emerging-market corporates, mainly because the valuations were so compelling,” Shamaila Khan, a money manager at AllianceBernstein LP, which oversees $457 billion, said by phone from New York on June 4. “You could get emerging-market investment-grade debt where you could’ve bought U.S. BB bonds. There’s still value left in the high quality names relative to where anything comparably rated in developed markets trades.”

Petroleos Mexicanos

Even after spreads between developing- and developed-nation company bonds tightened at the start of the year, emerging- market corporate securities rated BBB by Standard & Poor’s still pay an average yield of 4.05 percent, or 0.17 percentage point more than developed-market bonds rated three ranks lower at BB.

Dollar bonds due 2022 from America Movil SAB, the wireless carrier controlled by billionaire Carlos Slim, pay 3.45 percent, just 0.08 percentage point more than similar-maturity securities from Verizon Communications Inc. after tightening 0.37 percentage points since February.

“The thinnest sliver of the most liquid bonds in emerging markets have done really well this year and are now mostly fully valued, even versus their developed market peers,” Sunderji said. “It’s time for investors to progress past this very thin layer of the most liquid names.”