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Markets

Yield-hungry investors creep back to emerging-market debt

Buoyant dollar and faster US rate increases remain risks

An electronic board shows currency exchange rates in Buenos Aires' financial district.   © Reuters

TOKYO -- With long-term U.S. interest rates steadying at around 3%, bond investors are once again turning to the debts of emerging economies to rake in higher yields.

But volatility could return to the markets if the dollar strengthens against emergency-market currencies, making it crucial for investors to identify reliable borrowers.

Michael Cornelius, a portfolio manager at U.S. asset manager T. Rowe Price, acknowledges that volatility has subsided in bond markets in emerging countries. Some $15.5 billion flowed out of emerging-market bond funds from late April to early July, but another $1.2 billion has since flowed in, according to fund flow tracker EPFR. Cornelius added that he, too, scooped up Mexico and Argentina bonds when their prices dipped.

Investors in Japan have also shown an increased appetite for risk assets. The Philippines floated its first samurai bonds -- denominated in Japanese currency -- in eight years Wednesday, raising 154.2 billion yen ($1.39 billion), far above the 100 billion yen target. The offering drew large purchases from institutional investors, according to the lead underwriter.

Investors are having trouble finding investment vehicles offering decent yields. Even five-year bonds from major European economies remain in negative territory. Rates are not expected to rise much either in Japan, where the Bank of Japan has broadened its tolerance of long-term rate movements to as high as around 0.2%.

Among bonds maturing in three years or so, the debt floated Wednesday by the Philippines offers 0.38% -- compared with the 0.33% average for Japanese corporate bonds with a similar rating.

Speculation that China is easing up on its deleveraging campaign is also spurring bullishness on emerging-market debt. The People's Bank of China provided fresh liquidity in July to help keep companies with low-debt ratings from defaulting on their obligations. Real estate developers have also resumed issuing dollar-denominated bonds to raise funds overseas.

A repeat of what unfolded in the 1990s -- when higher U.S. interest rates helped trigger the currency crises of Mexico and Asia -- is considered remote at this point. The Federal Reserve is unlikely to surprise the market by accelerating rate hikes.

Still, some are sounding the warning bell, arguing that a depreciation of emerging-market currencies against the dollar would increase debt burdens and trigger fund outflows. Given that emerging economies face some $1 trillion worth of corporate and government bond redemptions a year, any change in the mood of the market could spark worries about financing.

Unlike in the 1990s, a broad range of governments and businesses today have taken advantage of low interest rates, making them susceptible to wild rate swings.

Cornelius says assessing how debt issuers use the lessons gleaned from a crisis to pursue economic and fiscal reforms has proved invaluable over his roughly three decades of managing emerging-market bonds. He foresees progress in Mexico under a new government, likewise in Argentina, which has secured assistance from the International Monetary Fund.

Simply chasing higher yields would leave investors exposed to big swings in interest and currency rates. Assessing the financial health of each issuer has become more important than ever.

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