Yields Speak Louder Than Ratings for Emerging-Market Investors
Emerging-market investors aren’t worrying much about the opinion of ratings companies these days as the hunt for yield outweighs what they consider rear-view assessments. Most of the developing nations that were downgraded in the past six months, including Brazil, Colombia and South Africa, saw their risk premium rise just briefly following the decision before quickly resuming their downward march amid a strong risk-on mood.
Part of the explanation is simple. Investors have been chasing high payouts in an environment of stubbornly low interest rates and willing to take on more risk to juice returns, at least until this week’s market turmoil. Meanwhile, growth is forecast to pick up in developing nations, with some of the biggest like Brazil and India engaging in market-friendly economic overhauls. But underpinning all of that is a simple fact: Markets are ahead of rating firms, which tend to take much longer-term views.
“Two words: backwards-looking,” Edwin Gutierrez, the London-based head of emerging-market sovereign debt at Aberdeen Standard Investments, said about rating actions.
Given the strong economic tailwinds, Jennifer Gorgoll, an Atlanta-based money manager at Neuberger Berman Group who helps oversees $16.7 billion in emerging-market debt, says the impact of rating actions on developing countries’ assets is going to continue to be mild.
“I’m not saying rating agencies don’t matter, but it’s a different environment now and negative rating changes can have less of an impact on spreads,” she said.
Measures of risk like credit default swaps and spreads on sovereign bonds fell in Colombia and South Africa after their latest downgrades and also in Brazil, which even managed to sell debt a week after being cut further into junk by S&P Global Ratings. In fact, investor demand for debt from Latin America’s largest economy was so strong that the government was able to close the deal at a lower yield than it initially sought.
“In 90 percent of the cases, market prices are more efficient than the ratings agencies,” said Sean Newman, a money manager in Atlanta at Invesco Advisers Inc., which oversees $5 billion in emerging-market debt.
Newman adds that in the case of lesser-known names or first-time issuers, like Tajikistan or Suriname, rating actions can still trigger market moves because investors don’t have enough data to easily price them. Ratings firms have more importance for those countries, he said.
It’s also true that once a nation tumbles out of investment grade, cuts deeper into junk territory are less important. Three years ago, Brazil’s sovereign bonds plunged to a record low after the nation lost its investment-grade rating. Many funds have restrictions on holding lower-rated securities, forcing them to sell when ratings cross the junk threshold.
“It’s when you switch indexes or become ineligible for certain big-grade accounts that it causes more market movement,” said Shamaila Khan, a money manager at AllianceBernstein LP in New York. “The big reactions on the rating front are when you go from investment grade to below investment grade.”
Lisa Schineller, a sovereign ratings analyst at S&P, says that investors often react to news much faster than the ratings firms, but that’s largely because companies like hers take a longer-term view and intentionally avoid moving the grades with every new development.
“Markets might perceive we’re not as timely,” Schineller said. “But we’re looking for an accumulation of evidence because our goal is a smoother, more medium-term focus.”