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 can sometimes provide 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 were able to 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’ve been part of the Steering Committee since debt restructuring talks began. 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, larger EMs. Rising DM interest rates also caused investor outflows from frontier bonds and 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 started its rate-cutting cycle in September. This should help ease pressure on EM currencies, as well as allowing EM central banks to also cut rates. As such, we also think this kind of environment could help spur demand for high-yield frontier bonds.
On the flipside, Japan hiked interest rates at the start of August. This opened pockets of value in the bonds of Pakistan, Nigeria, and Kenya thanks to the unwinding of the yen carry trade
On top of this, many frontier markets have implemented policies to reduce government deficits and debt accumulation. Robust support from institutions such as the International Monetary Fund and World Bank has helped. For example, Kenya recently initiated tax reforms and expenditure rationalisation to manage its public debt and fiscal deficit. It has also rationalised 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 been returning to the primary market with new issuance is up in multiple frontier countries, including Senegal and Côte d’Ivoire. At the same time, several countries are extending their debt maturities (managing their liabilities), thereby significantly reducing their credit risk for the next couple of years.
Final Thoughts…
Frontier bonds are riskier than other parts of EMD. However, skilled investors who have experience in this space can often be rewarded for taking that risk. We’re now at the start of a rate-cutting cycle in many places. Against this backdrop, we think high-yielding frontier bonds present a compelling opportunity for investors looking for potentially superior returns and diversification. Now could be the time to explore the final frontier.
Important Information: Foreign securities are more volatile, harder to price and less liquid than domestic securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries. High yield securities may face additional risks, including economic growth; inflation; liquidity; supply; and externally generated shocks.
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