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  • July 30, 2012

    Mike Conelius Mike Conelius, manager of the T. Rowe Price Emerging Markets Bond Fund

    In an environment where interest rates are low and the stock market changes from day to day, investors have been increasingly hungry for quality investments with relatively high yields. For these investors, bonds issued by emerging market countries could offer an attractive option. In a recent interview, T. Rowe Price Emerging Markets Bond Fund Manager Mike Conelius explains the surge of interest in these frontier bond markets.

    Better Economies Plus Better Yields

    At one time, emerging market bonds were viewed by many as the Wild West of the bond market. Most of the investable market was issued by countries with significant political, economic, and regulatory risks. Although yields were high, so was the potential volatility. But the financial crisis of the late 2000s, as well as the various debt and fiscal crises of many developed nations, have changed this perception dramatically.

    Conelius reels off a list of macroeconomic factors that are favoring emerging market bonds today. The debt ratings of these economies have been persistently improving. As a group, they issue less debt to investors than more developed nations. Whereas the debt-to-GDP (gross domestic product) ratio in developed nations is between 80% and 100%, this ratio is far smaller in emerging markets at between 35% and 40%.

    Conelius notes that more than 50% of the debt issued by various newer economies is now rated investment grade. However, some risks persist in emerging markets generally, and as a result, emerging market yields remain higher than their developed market counterparts. Although the difference is not nearly as wide as it has been in the past, most emerging markets offer a clear yield advantage over the U.S. bond market.

    Investors Have a Wider Range of Opportunities

    The relatively good economic health of emerging markets is also supporting the expansion of a corporate bond market in many emerging nations. From Conelius' perspective, this is a positive development. There are numerous globally competitive corporations in these nations, he argues, and emerging market companies tend to use less leverage than their developed market counterparts. Many have also moved more toward issuing debt denominated in their own currencies instead of in dollars, which reduces their risk.

    In terms of constructing an investment strategy, Conelius argues that selectivity and good analysis is critical. In peripheral Europe, he is emphasizing Iceland and Lithuania, as they are further along in resolving their debt crises. When it comes to corporate bonds, he cites companies in China and Brazil—nations that have a rapidly expanding middle class and growing demand.

    Outlook and Risks

    The investment markets have realized that emerging market debt is an attractive asset class underpinned by strong fundamentals, and these benefits have been made more appealing by all the economic turmoil being experienced by developed nations. The attractiveness of these securities should continue to draw substantial flows of capital. While Conelius welcomes this popularity, he thinks it's important for investors to understand the risks associated with these investments. Political and economic risks remain in place, and Conelius points out that many of these countries have benefited significantly from low U.S. interest rates. If U.S. rates were to rise, it could present a new challenge.

    At a more fundamental level, Conelius is optimistic. In his analytical work, he has noted a higher level of political commitment to maintaining fiscal discipline and effectively managing capital flows or commodity booms. Many corporate issuers also have good management teams, a quality that Conelius thinks is crucial. In Conelius' view, expert credit analysis remains necessary to be successful in emerging market bonds. But with a good investment strategy in place, the market could continue to pay dividends for investors.

    Stocks and sectors may not perform in line with the managers' expectations. All funds are subject to market risk, including possible loss of principal. Funds that invest overseas generally carry more risk than funds that invest strictly in U.S. assets, due to factors such as currency risk, geographic risk and emerging markets risk. Because of the concentration in rapidly developing economies, investing in emerging markets involves a high degree of risk. Bonds are subject to credit risk and interest rate risk. Investors should note that if interest rates rise significantly from current levels, bond fund total returns are likely to decline. Diversification cannot assure a profit or protect against loss in a declining market.

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