Local Bonds’ Unguided Track Traces

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JP Morgan’s 12th edition of its annual local bond market guide skirts recent volatility to promote long-term asset class trends, while citing structural foreign investor pullback the past five years. The past two years’ returns reversed previous losses, and Sharpe ratios at 0.5 have not suggested undue swings compared with other debt categories and equities. Almost 95% of emerging market government obligations are local currency and the $8 trillion universe is half the bond total. International ownership is down since the 2013 Taper Tantrum to a 27% share, while institutional flows have increased relative to the retail portion according to fund trackers.  The field is one-tenth of the global bond market, while developing economies are 40% of world GDP.  China, India and Brazil are 60% of the stock, and inflation-indexed instruments are concentrated in Latin America. In the past 15 years the average return has been 7.5% despite wide divergence in underlying currency values. Correlation is low with US Treasuries and higher with other industrial world credit, with real yields remaining steep in historical terms. Output growth should be in the 5% range through end-decade, and contained inflation should moderate rate hikes despite advanced economy quantitative easing fade. Fiscal deficits have worsened in recent years while current accounts have improved, and still managed and pegged currency regimes chiefly in the Middle East should stay intact. Overall government debt is 50% of GDP, and 2018 issuance should rise 3% to $600 billion, the reference projects. Foreign investor stakes vary widely, and China Korea, Israel and India have large non-dedicated participation, but control often ranks just behind domestic banks on the institutional scale. Pension funds have raised EM debt allocation to 5% of portfolios, but only one-fifth of plans are active. ETFs are small with less than $30 billion in assets, dominated by JP Morgan’s own $7.5 billion vehicle. Secondary trading has increased since 2010, and Mexico, India, Brazil and South Africa lead turnover, according to industry body EMTA’s regular surveys.

In Asia, beyond China’s Hong Kong Bond Connect and access liberalization, India lifted the foreign portfolio investment limit 1% to 6% of the government securities amount, and Vietnam and Sri Lanka are new frontier pockets, Malaysia extended onshore currency hedging and Korea duration out to 50-year Treasury bonds. In Europe Serbia, Ukraine and Kazakhstan are under investor consideration, and money poured into Egyptian T-bills following pound flotation under an IMF agreement. Nigeria may rejoin the benchmark GBI-EM index with relaxed foreign exchange curbs amid oil price recovery. Argentina continues to build its fixed-rate yield curve to reduce external funding dependence, Uruguay appeared with two instruments, and the Dominican Republic issued an inaugural index-eligible bond.  In contrast domestic corporate bonds are undeveloped at under 15% of GDP, with China accounting for almost three-quarters if the $7.5 trillion total. Korea and India are next averaging $500 billion, followed by Brazil, Mexico and Russia from $100-125 billion. Israel and South Africa are at $70 billion, and financials are over half the group and two-thirds mature within five years. Chinese quasi-sovereigns in banking and infrastructure are the top names, but only 10% are available through Euroclear to obscure the opportunity set, the review concludes.