Types of Bonds
International Bond Issues - Eurobonds, Global Bonds, Foreign Bonds
Emerging Market Bonds
Emerging markets are defined as those nations with economies which are developing. Among those considered emerging markets are some countries in Africa, Asia, Latin America, Middle East, Russia, and eastern/southern Europe. Emerging market bonds usually include government (or “sovereign”) bonds; sub-sovereign bonds and corporate bonds. Domestic emerging market bonds—those issued within an emerging market country—make up about three-quarters of the amount of debt in the emerging market bond markets but because it can be difficult for a variety of reasons to trade in domestic emerging bonds, emerging market bonds held by foreign investors are usually foreign or external emerging market bonds. The majority of external emerging market bonds are government bonds.
The emerging market bond market is a global market. Although in the 1980s the emerging market bond market was comprised mostly of struggling economies, the global emerging market bond market now contains a diverse range of emerging market economy bond debt which is rated from investment grade to speculative grade. The percentage of investment grade bond debt in this market, as measured by some key indices, now ranges from 25-50%.
It is important to note that Supranational Organisations such as the European Bank for Reconstruction, the Inter-American Development Bank, or the World Bank issue Eurobonds, including in the currencies of developing countries, in order to support emerging market economies. The level of risk differs in these various issues and investors must consider carefully the different types of risk they are taking on in with such an investment, whether the emerging market country is in Africa or Latin America, or one that may eventually join the European Union.
Risks of Emerging Market Bonds
Some individual investors have found bonds issued by emerging market governments are attractive because of their higher yields, but there are also higher risks to these investments.
Emerging bond investments are subject to currency risk (as with any bond outside an individual investor’s home currency); liquidity risk and credit quality risks.
Currency risk is because interest on the bonds may be paid in a weak or devaluing currency and therefore the payment will be worth less which makes the yield worth less than an investor might have expected. (Note that currency risk is not just a risk when investing in emerging bond markets; currency risk is a consideration for any bonds held in currencies outside your home market, a recent example from a non emerging market being if you are an investor residing in the UK or Europe with an investment in a US Government Treasury bond.).
Second, as it can be difficult to participate in the markets for emerging market bonds, liquidity risk exists with emerging market bonds because it may not be possible to sell them on the market when an investor wants to, or at least at a good price.
Third, it is very important that investors considering emerging market bonds or bond funds understand what credit ratings have been given to the debt issuer. As credit ratings influence the perception of the risk of the bond debt, the lower the credit rating, the more the issuer will have to offer in yield as compared to benchmark government bonds to attract investors. Higher yields for emerging market bonds reflect the fact that there is a possibility the issuer could default and not pay investors the interest and/or principal they are due. For example, some Italian investors, seeking higher yields, invested in the emerging bond market higher yields being offered on some Argentina government bonds. When Argentina defaulted, Italian investors lost money.
The most important point here is the emerging market bonds investments or funds may offer investors higher yields, but with higher yields come more risk that the investor will not receive his interest or principal payments. Take advice from a financial advisor to understand more about investing in this market.