While the historic amount of quantitative easing enacted by
the Federal Reserve may not be kick-starting the economy, it is
definitely pushing investors to search for higher yields and
riskier assets. High yield U.S. corporate debt has been the buzz
for the last couple of years. It seems now those investors have
been pushed further out to emerging market corporate debt.
According to the JP Morgan CEMBI Index, the average yield for
the Latin American corporate debt is around 4.3%, just 165 basis
points above investment-grade U.S. corporate debt. A Brazilian
company, Cielo, issued debt recently at just 225 basis points
above the comparable U.S. treasury debt, for a interest rate of
lowest ever for a Latin American company
at that maturity.
This is a boon to corporations that have been able to access
the market and now have ample liquidity for growth. Investors may
want to reassess the environment, however. What was once an
attractive risk-reward option for investors may be approaching an
Most retail investors get their emerging market bond exposure
through exchange traded funds that hold the debt and then pay a
monthly or quarterly dividend. The funds have been gradually
reducing their distributions as yields decrease and maturing debt
is reinvested in more expensive bonds.
One of the best examples of this is the Market Vectors LatAm
Aggregate Bond (
). The fund paid its first distribution of $0.165 per share in
July 2011, for a yield of 7.7% but has seen distributions fall
steadily to just $0.108 per share for a yield of 4.2%. While
demand for bonds has pushed the funds shares higher to a 10%
return since May 2011, low yields and a shorter spread may mean
limited appreciation from here on out.
The loss of yield is not exclusive to investments in Latin
American corporate debt. The Morgan Stanley Emerging Markets (
), a fund investing in sovereign and quasi-sovereign debt, paid
an attractive 11.6% yield with its first distribution in 2007 but
has since seen the yield fall to just 5.9% on a decrease in
payment amount and rising share prices. The shares have returned
9.8% on an annualized basis over the last five years, but must
now reinvest maturing bonds in an extremely low-yield
Companies in the region generally have solid balance sheets
with a low amount of debt so the bonds are relatively secure to
maturity. This may be of little solace to investors that buy in
at the height and then see their low yields eaten away when
current rates increase and bond prices drop.
The saying goes, "Don't fight the Fed," and it is becoming
increasingly relevant as investors get pushed further up the risk
spectrum. When rates start increasing in the U.S. or if we
experience another liquidity event, the bonds and the funds
holding them are going to wipe out any marginal yield that might
have been collected.