Emerging market debt: Investors desperate for yield and protection against a sagging dollar are flocking to bonds denominated in emerging market currencies. Some appear to be overlooking one important aspect amid the frenzy. If things go bad, local sheriffs playing by different rules will lay down the law.
Easy money may not be leaving investors with much choice. The world has been awash in liquidity thanks to low interest rates in the developed world since the financial crisis. And the Federal Reserve is about to give asset prices a boost with another round of quantitative easing. Yields in the developed world are already incredibly low, but so are those in dollar-denominated emerging market debt, the ones most accessible to international investors.
That has left many ogling local currency debt. Not surprising. These bonds, which make up the bulk of bonds in emerging markets, can offer yields north of 10 percent while providing a hedge against the dollar's diminishing fortunes.
So far this year, investors have poured $22.6 billion into local currency funds, more than four times the amount in 2007, the last boom year, according to fund tracker EPFR. And there's much where that came from. The world's biggest investors have some $71 trillion under management. So even if they shifted their allocation just a little, it could easily drive yields down.
For now, they may still look enticing compared to what else is available. They can be more difficult to purchase depending on a country's rules on foreign ownership. Moreover, most are also ruled by local laws rather than more established financial-center jurisdictions such as New York and London.
Emerging economies can boast of savings and growth. But full implementation of the rule of law is something else altogether. Corruption is still rampant in investor-darling nations like Brazil, India and Indonesia, according to a survey released this week. That means disagreements or defaults may not be as smoothly handled as western investors are typically accustomed to.
They may feel they're being adequately compensated for the exposure. But if a wall of easy money keeps lapping up on foreign shores, the risk premium may be washed away.
