However, frontier bonds have outperformed EMD over one, three, and five years.1 The bottom line: investors get paid to take on the additional risk.
Why frontier bonds?
Frontier bonds give investors access to dynamic and diverse parts of the market unavailable in a traditional EMD portfolio. Frontier managers can go off-piste to find the most compelling opportunities wherever they might be.
This includes when a country defaults. In the run-up to such a credit event, bond prices slump. This provides an ideal buying opportunity for investors with on-the-ground insights, legal expertise, and, ultimately, patience.
Take Ghana. It defaulted in December 2022, causing its bond prices to plummet. At the time, we could pick up ten-year debt in the mid-to-high 30s US cents. Today, the bonds trade at around 53 cents. That’s a near 15-point rise in bond prices.
We believe Ghana’s proposals have been well-informed and achievable. The country has agreed to reduce its debt-to-GDP ratio to 55% by 2028, putting it on a path towards debt sustainability. Talks on the restructuring of its external debt are ongoing.
Where next for frontier bonds?
In 2022, numerous external shocks hurt frontier markets. The spike in inflation disproportionately affected frontier markets due to the higher mix of food and energy in the consumption basket versus developed markets (DM) and, to a lesser extent, mainstream EM. Rising DM interest rates also caused investor outflows from frontier bonds into DMs.
The picture today is markedly different. Inflation is cooling, and DM central banks have started cutting interest rates. Indeed, the US Federal Reserve began its rate-cutting cycle in September. This should ease pressure on EM currencies and economies and allow developing market central banks to cut rates. We also think this will spur demand for high-yield frontier bonds.
On the other hand, Japan hiked interest rates at the start of August. This opened pockets of value in Pakistan, Nigeria, and Kenya, thanks to the unwinding of the yen carry trade.
In addition, many frontier markets have implemented policies to reduce government deficits and debt accumulation. Support from institutions such as the International Monetary Fund and World Bank has helped. For example, Kenya recently initiated tax reforms and expenditure rationalization to manage its public debt and fiscal deficit. It has also rationalized non-priority spending.
Elsewhere, Zambia agreed to a $3 billion restructuring deal with bondholders earlier this year. Sri Lanka is likely to follow in the coming months. Ukraine, despite fundamental challenges, also restructured its debt in record time. All else being equal, this should have a positive spillover effect on other parts of the high-yield market.
Confidence has also returned to the market. Primary issuance is up in multiple frontier countries, including Senegal and Côte d’Ivoire. At the same time, several countries are extending their debt maturities (liability management), significantly reducing their credit risk for the next couple of years.
1 "Emerging market debt: What to watch for in 2024." abrdn, January 2024. https://www.abrdn.com/en-us/institutional/insights-and-research/emerging-market-debt-what-to-watch-for-in-2024-us.
Important information
Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.
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