Frontier Debt Shines as Unlikely Haven in World of Rising Rates

(Bloomberg) -- As the hunt for investments that can withstand rising interest rates gathers pace, frontier assets are gaining popularity over their larger emerging-market peers.

The bonds of the world’s least-developed economies have returned 2.6% this year, keeping pace with their 2020 performance, while higher-ranked emerging-market debt has lost almost 2%, reversing some of last year’s 5.3% advance, according to JPMorgan Chase & Co. indexes.

With speculation growing that the world’s post-pandemic economic recovery is fueling inflation, the bonds of smaller developing nations are luring buyers as their securities tend to be of shorter duration -- meaning they are less sensitive to expectations for interest-rate increases. The average duration of frontier-market sovereign bonds is six years, compared with 7.9 years for traditional emerging markets, JPMorgan indexes show.

“People are still worried interest rates have to rise” and are looking for higher yield and less interest-rate duration, said Leo Hu, who co-manages the $7 billion Emerging Markets Debt Hard Currency Fund at NN Investment Partners in Singapore. Frontier bonds may return at least 9% in the next 12 months, he said.

The burgeoning interest in frontier assets nonetheless represents a threat to the global economy as central banks move back into policy-tightening mode. Less developed nations, such as those in Africa, present a higher chance of default than their larger emerging-market peers. And the more funds they attract, the greater the threat of potential contagion should rising borrowing costs hamper economic growth.

Into Africa

In terms of geography, money managers who specialize in frontier assets are almost united in favoring Africa, saying the region will benefit the most from rising raw material prices. These include Angola, Ghana and Zambia -- even though the latter became the first African country in the Covid-19 era to default when it skipped a Eurobond payment last year.

Zambia has benefited as copper has risen to record highs, with demand bolstered by the global recovery and the transition toward green energy. The metal accounts for almost 80% of Zambia’s export earnings. The nation’s dollar debt has returned 24% this year amid prospects of an International Monetary Fund bailout, second only to Ecuador among the roughly 75 emerging markets tracked by Bloomberg Barclays indexes.

Angola, Africa’s second-biggest oil producer, is another favorite. A slide in crude prices last year triggered by the pandemic led the country to seek $6.2 billion of relief from its major creditors, easing fears of a default in one of the continent’s most-indebted countries. Angola’s bonds have returned 12% this year, according to a Bloomberg Barclays index.

African bonds also stand out from their peers in terms of yields. Ghana’s 2025 securities currently yield 6.3%, while similar-maturity Angolan debt yields 6.9%, according to data compiled by Bloomberg. That stands in contrast to traditional emerging markets. The 10-year bonds of Indonesia yield just 2.3%. Mexico’s yield 3.1%.

“We have been allocating more to frontier sovereign credits,” said Jens Nystedt, a fund manager in New York at Emso Asset Management, a specialist on fixed-income investments in emerging markets overseeing $6.8 billion. “In particular, we like the outlook for Nigeria, Ghana and Angola given that they would be some of the main beneficiaries from higher oil prices.”

Bailout Program

Sentiment toward frontier markets was also boosted this year after the IMF announced a plan to create $650 billion in additional reserve assets to help developing economies cope with the pandemic.

IMF support has been crucial for the likes of Pakistan, which raised $2.5 billion in March after the resumption of a $6 billion bailout program. Ecuador’s new government plans to reach a deal with the IMF to ensure financial stability and unlock some of the funds related to the $6.5 billion financing agreement reached last year.

Frontier-nation bonds offer higher yields for a reason -- they are judged to have a higher chance of default. But many fund managers aren’t deterred.

“There are quite some risks, such as the worsening of the pandemic or too much stimulus, but we stick with the rosier scenario for frontier markets,” said Edgardo Sternberg, co-manager for emerging-markets debt portfolios in Boston at Loomis Sayles & Co., which oversees $3.5 billion of developing-nation bonds. “Frontier markets should continue to outperform,” he said.

Central bank meetings in Nigeria, Kenya and Angola will be in focus this week. Elsewhere, policy makers in Indonesia and South Korea will also decide on interest rates.

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Rates on Hold

• Nigeria is likely to keep its key interest rate unchanged on Tuesday as the fragility of its economic recovery outweighs concerns about inflation, which remained more than double the the bank’s official target ceiling in April
• Monetary authorities in Kenya and Angola are also expected to hold rates on Wednesday and Friday, respectively
• While central banks in Indonesia and South Korea will also likely keep rates steady this week, the focus will be on the signs for a change of tack in the months ahead
• While Colombia’s central bank will convene on Friday, the gathering is not a monetary policy meeting, according to Bloomberg Economics

Economic Data

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