The attraction of emerging market bonds
In one hugely significant respect, emerging nations surpass their western counterparts: in the quality of their debt.
While we in the West have spent like drunken sailors who won the lottery and have long forgotten where their ships are, developing markets have quietly established strong balance sheets.
Their debt to GDP ratio is about 40% compared with more than 100% in many developed countries.
This new world order is enticing investors on an unprecedented scale. So far this year emerging market corporate and sovereign bonds have been issued at a record pace.
Borrowers, including governments and companies, have raised almost $300 billion to date - a 10% increase on the same period in 2009, which was itself a record year, according to data from Thomson Reuters.
The rationale behind this wave of investment tells the same story as the enthusiasm for dividend income from developing markets.
The old world order is changing. While a number of western countries - Greece is just one among many - have large budget deficits, huge indebtedness and poor growth prospects, emerging market countries have, in the main, strong economies, manageable budget deficits, current account surpluses and good growth forecasts.
In addition to bonds issued by companies, there are two main types of emerging market sovereign debt: hard currency bonds denominated in US dollars, and local currency bonds. The latter dominate the market, but are more risky, although potentially more rewarding.
The risks are those usually associated with debt issues, namely fluctuations in the issuer's economic or financial fortunes, and the ability to meet payment obligations.
However, with emerging economies, the risks are heightened by potential economic and political volatility. These factors are less worrying than in the past, but investors must bear them in mind when assessing the attraction of emerging market bonds.
And in the case of local currency bonds there is also the potential for ups and downs in the currencies in which they are denominated.
This article was originally published in Money Observer - Moneywise's sister publication - in August 2010
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
The total money value of all the finished goods and services produced in an economy in one year. It includes all consumer and government consumption, government spending and borrowing, investments and exports (minus imports) and is taken as a guide to a nation’s economic health and financial well being. However, some economists feel GDP is inaccurate because it fails to measure the changes in a nation's standard of living, unpaid labour, savings and inflationary price changes (such as housing booms and stockmarket increases).
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.