World-Beating Frontier Rally May Move to Local-Currency Bonds

(Bloomberg) -- Overseas notes from the least-developed countries are the world’s best performing bonds this year. Securities denominated in local currencies may be about to play catch-up.

So-called frontier nations such as Kenya, Ecuador and Nigeria have all posted returns above 13.5 percent, far above the global sovereign average of 2.4 percent, as a more dovish Federal Reserve triggered a global risk-on environment and a hunt for yield.

With a lot of good news already priced in, some money managers and analysts including Aberdeen Asset Management’s Edwin Gutierrez and Oppenheimer & Co.’s Nathalie Marshik say that concerns about a global growth slowdown could start to erode returns from frontier-market overseas bonds. Marshik says that in a low growth environment, investors should look to developing countries with the strongest balance sheets and external positions, recommending the local-currency bonds of emerging markets including Egypt, and frontiers such as Nigeria and the Dominican Republic.

“Local-currency debt is what looks interesting, because it has been the big laggard year-to-date,” said Gutierrez, a London-based money manager. He says he’s still long frontiers, but has turned his focus to domestic markets and is trimming risk after the rally. “If you believe that EM still has legs, this is the next stage of the rally.”

While a strong dollar last year put pressure on emerging-market currencies across the board, a newly dovish Federal Reserve may change that calculation. If the dollar falls, currencies from developing countries will have space to outperform.

“The Fed slowing down the pace of hiking will help for sure,” Oppenheimer analyst Marshik said in an interview from New York. “Global growth is definitely something to consider, but in general, low U.S. rates mean a strong carry trade.”

To contact the reporter on this story: Justin Villamil in Mexico City at jvillamil18@bloomberg.net

To contact the editors responsible for this story: Philip Sanders at psanders@bloomberg.net, Brendan Walsh

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