NEW YORK, Dec 19 (IFR) - Emerging market bonds fell victim to indiscriminate selling this week, as weak oil prices and low liquidity sent investors running for cover ahead of potential redemptions.
At its nadir on Tuesday, the sell-off had wiped out two-thirds of the gains achieved by emerging market sovereign bonds so far this year.
Total returns on the EMBI Global Diversified Index were down to 3.5% on Tuesday from around 9.5% at the end of November.
Exacerbated by the lack of liquidity in the market towards the end of the year, the drop was so pronounced that EM sovereigns did even worse than US high-yield in the first three weeks of December - in spite of the latter’s strong exposure to an embattled energy sector.
“I suspect some of the overreaction had to do with portfolio managers anticipating outflows and having to raise cash,” said Gorky Urquieta, co-head of emerging markets debt at fund manager Neuberger Berman. “But on a medium-term horizon, investors are going to look at this from a different perspective.”
Comforted by solid returns in the first 11 months of the year, some portfolio managers might have been caught off-guard by the sudden deterioration in the asset class.
“We had a pretty good rally up to November and cash levels were on the lower side,” said Sergei Strigo, head of emerging market debt at Amundi Asset Management in London, who reckons fund managers have increased their cash holdings to between 5% and 10% of total assets to cushion against potential redemptions.
With several EM credits becoming too cheap to ignore, however, accounts have already started dipping their toes back in the market, helped by a modest recovery in oil prices and a decent amount of short covering.
Venezuelan bonds, for example, bounced back to the mid-40s in the second half of the week after trading in the 30s on Tuesday - well below their expected recovery value.
Meanwhile, spreads of Brazilian state-run oil company Petrobras blew out as wide as 600bp on Tuesday before retracing to around 480bp on Thursday.
According to Urquieta, even countries such as Russia - which stared into the abyss of a full-blown currency crisis this week - look like good buying opportunities to some.
“The Russian sovereign was trading almost 700bp wide to US Treasuries on Tuesday - wider than Rwanda,” said Urquieta. “But when you look at the balance sheet of Russia, under most scenarios that looks like a very decent entry point.”
Away from oil-related names, Urquieta said his firm saw opportunities in Turkey, South Africa and even the Dominican Republic, all of which were hit by this week’s capitulation in spite of being net beneficiaries of lower oil prices.
Yet while recognising that the sell-off has created opportunities, others warn of the dangers still posed by highly volatile oil prices.
“Value has returned in EM credits - especially in better ones such as Mexico, Indonesia, and even Brazil, where fiscal prospects have improved,” Deutsche Bank analysts said in a note to clients on Wednesday. “But stabilisation in the oil market is required before positioning for recovery.”
While portfolio managers generally agree that institutional investors remain committed to the emerging market asset class, larger than expected outflows could put further pressure on bond prices, prompting some clients to reconsider their asset allocation strategy.
Outflows from EM dedicated bond funds intensified to US$1.96bn in the week to December 17, according to EPFR data quoted by Barclays, up from US$940m the week before.
“Clients have become more concerned,” said Strigo at Amundi. “They are asking more questions.”
Reporting by Davide Scigliuzzo; Editing by Marc Carnegie and Matthew Davies