Emerging market investors cast wary eyes on Argentina

It is undeniable that the Maltese love to make a profit. After all, who doesn’t? This week the Malta Financial Services Centre writes in this paper, see page 8, about the dangers being faced by investors in emerging markets. The danger to the already precarious position of emerging markets bonds, of course, is clear and present through the potential trickle-down effect from Argentina’s current fiscal crisis.
If Argentina fails to pay out the interest to investors holding bonds issued by the country, there could be severe implications on other Latin American countries and on other countries with emerging markets. However, so far there have not been too many ripples amongst Argentina’s fellow emerging market countries, except for its neighbour Brazil.
Political risk has always presented the greatest danger to investors in emerging markets. However, prior to 11 September few would have even ventured to guess that this type of investment risk, in the form of terrorism, would leave its mark on even the world’s most developed market – that of the United States.
The resulting blow received by the emerging markets across the world was a heavy one, especially since they were already struggling with a third quarter downturn. In fact, data demonstrates that the last quarter was one of the worst ever for the category, with global equity emerging markets funds dropping an average of 22.3 per cent.
Despite the evident risks involved in investing in emerging markets, the bond and fund sector has continually been one of the favourite tools of the Maltese investing public, which, as is the case for investors the world over, tends to succumb to the temptation of earning high coupon interest payments.
However, the primary misconception in the realm of emerging markets is that the high coupon interest offered is the direct result of the high risk associated with these types of investments. The reasoning behind it is that investors must be compensated for the volatility of emerging markets, which is caused by a variety of factors - such as their susceptibility to economic downturns or international sentiment turning its back on the country or region the fund or bond in question is issued by. It accordingly follows that the higher the risk, the higher the interest.
But with coupon interest payments of between nine and 11 per cent, investors are easily seduced into dumping their savings – lock, stock and sometimes barrel - into such vehicles. Lending further ‘security’ to the investment, emerging markets bonds are also denominated in a trusted currency – other than that of the issuing country – and the fact that they are issued or guaranteed by a sovereign government.
To completely cease investing in such funds is by no means being advocated. Instead, good advice would point investors to evenly distributing their portfolios between the high risk, high yield and the lower risk, lower yielding funds.
Investors should also look closely at the rating of the emerging market bond they are interested in, as the MFSC bluntly states that a cursory look at the ratings given to such bonds clearly indicates that they are considered to be speculative and below investment grade. All international bonds are rated by rating agencies and are based on an analysis of the issuing country’s financial status, its economic and debt characteristics and the revenue sources that are to secure the bond. The weight of such ratings are far too often misunderstood or underestimated.