Mon, Aug 24, 2015 page13

• Investors race to escape risk of uncertain bonds

  RAPID RETREAT: High-yield, high-risk bonds have helped develop poor nations through cheap loans, but as the market destabilizes, bond investors are beginning to bail out

  • NY Times News Service
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  The large mutual funds that helped fuel rapid growth in developing countries have begun hastily retreating from those investments, contributing to the recent sharp decline in global markets.

  In the past week alone, investors pulled US$2.5 billion from emerging-market bond funds, the largest withdrawal since January last year.

  The world’s fastest-growing economies — led by China — have been propelled by soaring commodity prices, robust currencies and access to cheap loans, primarily through the sale of high-yield, high-risk bonds.

  However, China’s decision to devalue its currency has set off a chain reaction of panicked selling around the world, as the devaluation increased concerns that growth in China was slowing and that other countries might follow with their own devaluations.

  The notion unnerved bond investors, who began to retreat out of fear they would not be repaid. General unease about a global economic slowdown spread to stocks, which many have believed to be overvalued and due for a decline.

  “The growth rates for many of these countries were vastly overstated,” said Harvard Kennedy School of Government professor Dani Rodrik, who has studied the impact of foreign capital flows in developing economies.

  “It was all very unsustainable,” he said.

  The selling spree has raised concerns among regulators and economists about a broader contagion that could make it difficult for individual investors to withdraw money from their mutual funds.

  While these funds do not use borrowed money, as did the banks that failed during the mortgage crisis, they have invested large sums in a wide variety of high-yielding bonds and bank loans that are not easy to sell — especially in a bear market.

  If investors ask to be repaid all at once — as happened in 2008 — a run-on-the-bank scenario could unfold, because funds would have difficulty meeting the demands of people wanting their cash back.

  In January, economists at the Bank for International Settlements (BIS), a clearinghouse for global central banks, published a study that highlighted how fast US dollar-based lending to companies and countries outside the US had increased since the 2008 global financial crisis — doubling to more than US$9 trillion.

  What struck the authors most was that this growth was coming not from global banks, but from US mutual funds buying the bonds of emerging-market issuers.

  Large fund companies like BlackRock Inc, Franklin Templeton Investments and Pacific Investment Management Co LLC (PIMCO) have been inundated with money from investors eager to invest in the high-yielding bonds of emerging-market corporations and countries.

  For example, PIMCO’s Total Return bond fund has 21 percent of its US$101 billion in assets invested in emerging-market bonds and derivatives.

  Among the many beneficiaries of this largesse were commodity-driven borrowers such as the state-owned oil companies Petrobras in Brazil and Pemex in Mexico, the Russian state-owned natural gas exporter Gazprom and real-estate developers in China.

  One of the more extreme cases of this bond market frenzy was Mongolia. In 2012, with expectations high that the relatively tiny economy would reap the benefits from China’s ceaseless appetite for raw materials, the government sold US$1.5 billion worth of bonds, with demand from investors reaching US$10 billion.

  That meant, in effect, that the country was in a position to borrow an amount twice the size of its US$4 billion GDP.

  Three years later, the IMF is warning that Mongolia might not be able to make good on these loans — 14 percent of which are owned by Franklin Templeton, according to Bloomberg data — and the yields have shot up from about 4 percent to 9 percent.

  Of course, a Mongolian bond deal gone bust does not spell disaster, but it illustrates the risks global mutual fund investors were willing to take on in their desire to load up on high-yielding securities.

  Overall, Brazil, China, Malaysia, Russia, Turkey and others have sold more than US$2 trillion in bonds, mostly to US mutual fund companies, since 2009. Now the reverse is occurring, led by a slowing Chinese economy, and as that money heads for safety, local currencies are plunging.

  In a follow-up paper this month, BIS economists warned of the consequences if bond investors sell these positions in a panic at more or less the same time. And they point out that, because bond funds have become so large and own so many of the same securities (many of which tend to be hard to sell), a bond-selling panic can spread quickly.

  An emerging markets debt investor at Babson Capital Management LLC in Boston, Ricardo Adrogue, said it is the extreme declines in the currencies of Malaysia, Mexico, Russia and Turkey that worry him — not so much the Chinese devaluation.
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