Buy Emerging-Market Bonds on Fund Inflows, Morgan Stanley Says

By David Yong

Nov. 2 (Bloomberg) -- Investors should take advantage of any dips in emerging-market bonds by adding to their holdings because global funds are likely to pump more money into the securities through early next year, according to Morgan Stanley.

Funds focusing on these assets have moderate risk levels against their benchmarks and the balance of demand and supply remains supportive of further price gains in the coming weeks, London-based strategists Rashique Rahman and Regis Chatellier wrote in a research note dated Oct. 30.

Developing nations’ debt slumped in the past three weeks as concern about the strength of the global economy’s recovery from a recession curbed risk-taking. Investors demanded a yield premium of 3.22 percentage points over U.S. Treasuries to buy emerging-market sovereign debt as of 1:47 p.m. in Singapore, according to JPMorgan Chase & Co.’s EMBI+ Index. The spread fell to 2.90 points on Oct. 14, the least since August 2008.

“The end of the year is traditionally favorable for fund inflows as strategic mandates are made,” Morgan Stanley said in the report. “Bouts of weakness, such as the one just experienced, are to be expected and should be bought in to, with a view to further asset price gains into early next year.”

Cumulative fund inflows into emerging markets have reached $8.1 billion since July, Morgan Stanley said, citing data published by Cambridge, Massachusetts-based EPFR Global, which tracks $10 trillion of assets worldwide. The trend of low-yield money-market outflows and the inflows into high-yielding assets remains in place, the U.S. lender said.

Average Rating

Morgan Stanley said the overall risk adopted by emerging- market investors remains low as its internal indicators show the share of investment-grade credits has increased as a proportion of total allocations in funds dedicated to emerging markets.

“This suggests that emerging-market funds will still need to add exposure to be in line with their benchmark,” the strategists wrote.

Sales of dollar-denominated bonds by governments and companies in emerging markets amounts to $151 billion so far this year, versus $64.6 billion in 2008, according to data compiled by Bloomberg. This year’s tally will be the highest total for any year since at least 1999. Malaysian oil company Petroliam Nasional Bhd. and the governments of the Philippines, Sri Lanka and Brazil are among the sellers.

The average rating of new bonds issued this year has been BBB+, which is three levels above the BB+ average rating of the main emerging-market indices, Morgan Stanley said. As they are added to fund portfolios, it has the effect of raising the credit quality and reducing the risk exposure of the funds against their benchmark, the bank said.

Redemptions

The EMBI+ Composite Index, which tracks total returns on the foreign-currency debt of developing nations, reached 496.10 on Oct. 14, the highest close since JPMorgan started compiling the benchmark in 1993. It’s since slipped 1.9 percent to 486.90, trimming this year’s advance to 24 percent.

Morgan Stanley estimated sovereign bond redemptions at $1.2 billion and corporate debt at $6.4 billion for this month, less than its forecast for debt sales totaling $5 billion.

“We do remain concerned about possible indigestion for emerging-market credit of massive new supply but this is a consideration for the first and second quarter next year,” Morgan Stanley said. “So long as prospects for global recovery remain intact, the abundant global liquidity will increasingly flow to higher-yielding asset markets.”

To contact the reporter on this story: David Yong in Singapore at dyong@bloomberg.net.