This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on May 2 - 8, 2016.

Look anywhere in the world and you’ll be hard-pressed to find an investment that is as profitable and safe as the dollar-denominated bonds of higher-rated companies in developing nations.

Their 5.6% rally this year, while not the biggest in absolute terms, eclipses more than 130 assets from US Treasuries to gold and even bitcoin when volatility is factored in, according to data compiled by Bloomberg. The 19% jump in Colombian stocks might sound like a better deal, but price swings in Bogota exposed investors to six times more risk. When both factors are considered, the gains in emerging-market corporate dollar bonds come out twice as good, the data show.

That marks a turnaround for the securities after last year’s sell-off fuelled by concern that higher US interest rates, currency swings and a slowdown in China’s economy would spur corporate defaults in emerging markets. Now, investors are returning, buying the bonds of borrowers such as oil company Petroleos Mexicanos and Brazilian iron ore exporter Vale SA in a sector that has low volatility and yields that are an average two percentage points more than Treasuries.

“There was too much fear earlier and the sell-off went to ridiculous levels,” said Luc D’Hooge, who oversees US$700 million as head of emer-

ging-market bonds at Vontobel Asset Management in Zurich and bought Latin American investment-grade notes including Pemex and high-yield credit in Africa this year. “The bottom line is that the default risk in emerging markets is not massive. The spreads we saw last year were unjustified and that is what has led to this performance.”

The travails of 2015 prompted economists from the International Monetary Fund to the Bank for International Settlements to warn investors that weakening currencies would raise the cost of repayment in emerging markets and lead to increased defaults. The threat failed to materialise this year as state support, hedging strategies and a recovery in exchange rates helped companies not only to pay off their debts, but also to refinance at lower cost.

That boosted investor appetite for developing countries, helping sovereign and corporate bonds in both investment and high-yield grades to post the best four performances in a broad swathe of global assets. An analysis of 65 stock markets from Canada to New Zealand, currencies from the US dollar to the Danish 

krone, commodities including oil and orange juice, Treasuries, corporate bonds and the biggest exchange-traded funds failed to show a better score on risk-adjusted returns.

The bounce-back in oil and commodity prices played a key role in the performance. Companies from these two industries dominate the sweepstakes in emerging-market bond gains. The 2042 notes of Brazil’s Vale and 2022 notes of Mexico’s Industrias Penoles SAB de CV have returned more than 17% this year.

The rally has been marked by continued pessimism among some money managers and could fizzle out with a change in any of the factors including the US Federal Reserve’s dovish stance, China’s stimulus plans or the stability in crude prices, some analysts say.

“It’s a reluctant type of rally,"Larry Hatheway, the chief economist at GAM Holding AG in London, said by phone. “What certainly propels it is the absence of alternatives.”

Extreme Pessimism

Others see a need for continued caution against gains overshooting fundamentals.

“We were coming off extreme pessimism last year,” said Alberto Gallo, the head of macro strategies at Algebris Investments Ltd in London. “It is too early to call it an extraordinary whole year. Investors still need to be very selective about what they buy.”

For now, investors are seeking to escape almost US$8 trillion of global sovereign notes that offer nothing more than negative interest rates. Emerging markets help them in three ways: (i) their bonds typically have higher rates; with (ii) those issued by investment-grade borrowers being relatively safe; and (iii) the US dollar securities among them strip out the currency risk.

“Now people are asking why invest in bonds with negative yields because you are sure to lose money,” Vontobel’s D’Hooge said. “If you are ready to accept a little bit of risk and volatility, you can make much more returns.” — Bloomberg

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