Investors are edging back into bonds from the riskiest developing countries, even as they remain concerned about a string of defaults.
The spread, or extra yield, that investors demand to hold speculative-grade debt and tracked by a key emerging market bond index from JPMorgan Chase & Co. over U.S. Treasurys narrowed to 8.5 percentage points on Thursday. The spread, which reflects borrowing costs in countries such as Bahrain and Sri Lanka, had blown up to 12 points in late March, topping the 11.6 points reached during the 2008 financial crisis.
The blow to the global economy from the coronavirus pandemic, combined with a plunge in oil prices, has raised the risk of defaults in countries like Zambia and Ecuador. Governments in some emerging markets have been particularly hard hit as they try to step up spending on healthcare and stimulus measures, while plunging currencies threatened to boost the cost of payments on their foreign debt.
As investors turned jittery in March, they sold off risky assets indiscriminately, according to Jan Dehn, head of research at Ashmore Group. The mood has turned as new cases around the world have slowered and major economies have reopened.
“The problem with markets is that they overreact, they end up pricing in far more defaults than we get,” said Mr. Dehn, who bought up emerging market government bonds in March and April. “The real reason why these markets are reeling so much, is because they shouldn’t have been sold in the first place,” he added.
Even before the pandemic, Venezuela, Argentina and Lebanon had started defaulting on sovereign bonds. In recent weeks, Zambia and Ecuador have moved toward restructuring debt.
Following a surge in withdrawals from emerging-market stocks and bonds earlier this year, the Group of 20 economies, including the U.S., China and the European Union, in April gave some of the world’s poorest countries the green light to suspend debt payments. They also called on private creditors to offer comparable debt suspensions.
Some investors still see a buying opportunity.
An investor tracking JPMorgan’s Emerging Market Bond Index Global Diversified index could make 32% in dollar terms over five years in compound returns, assuming yields and currencies remain unchanged, according to Mr. Dehn. That compares with 55% for an investor buying the high-yield part of the index alone and 3.8% for 10-year Treasurys, he predicted .
Emerging markets that are considered more creditworthy have recovered even faster since the March rout. Spreads on investment-grade debt tracked in the benchmark JPMorgan index narrowed to 2.12 percentage points on Thursday, from a high of 4 percentage points earlier in the year. It had reached almost 7 percentage points in 2008.
The definition of emerging markets has expanded rapidly in recent years to include countries like Saudi Arabia and other Gulf Cooperation Council nations, which are seen as relatively strong borrowers likely to repay their debts.
Over 50% of its emerging market sovereign bond index was made up of investment-grade countries’ debt by the beginning of this year, according to JPMorgan, up from 25% at the beginning of 2000.
“The market is definitely more mature than 2008 in terms of the number of issuers, how large the asset class is, how many different investors there are,” said Anthony Simond, an investment manager at Aberdeen Standard Investments.
A man wearing a face mask walks past the U.S. Treasury Department building in Washington D.C.
Photo: Xinhua/Zuma PressSince the mid-March selloff, some less developed countries have issued fresh debt on international markets, underscoring investors’ revived appetite. Investment-grade sovereigns, like Panama, Israel and Indonesia, were among the first to sell new bonds in late March and early April.
More recently, high-yield countries have followed suit. Last month, for example, Egypt raised $5 billion while Bahrain raised $2 billion.
The rally in stocks and bonds is being fueled in part by the flood of easy money that central banks and governments have unleashed to bolster economies.
“Especially in the past month or so, there has been a lot of hunt for yield,” said Peter Kisler, portfolio manager at North Asset Management.
Write to Avantika Chilkoti at Avantika.Chilkoti@wsj.com
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