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Monday, July 1, 2013

This One Was An Accident Waiting to Happen....

Why investors thought that it as worth the risk to "reach for yield" by picking up 3% over Us treasury bonds and even to get the same yield of US high yield never made sense to me. Investors took on political risk and in the case of local currency denominated bonds currency risk currency risk as well. Add into that the limited history for these markets and no test of liquidity in the market and the risk/return was pretty clearly poor to any astute observer.

Add into this another factor. While emerging market stock indices are weighted to the companies in the stronger economies often countries that issue little debt the weighting in the bond indices is quite the opposite.

For instance the MSCI emerging markets index (ETF emb) has a 6.9% weighing to Turkey and no holdings in South Korea IEMG the emerging markets ishares  has a near zero weighing in Turkey and an 18.7% weighing in South Korea.

Add in the fact that the financial services industry was more than happy to offer new "product" in this area through new mutual funds, new ETFs and "research reports" on the importance of investing in emerging markets and you get plenty of money flowing in. This in turn produces upward moves in price and more investors.

In other words a classic accident waiting to happen if the political and currency risks show up...which is exactly what happened as the WSJ reported.

For Investors, Emerging Rethink

Prices on bonds issued in emerging economies have lost 9.5% of their value since an all-time record high hit in May, according to the J.P. MorganJPM -0.68% Emerging Market Bond Index. At their lowest point last week, they were down 12% from that peak. The pace of the selloff recalls late 2008, when emerging-market bonds fell almost 30% in less than two months. Bond prices move in the opposite direction of yields......

And of course the selloff puts the whole process in reverse. Investors who didnt understand the risks get hit with big losses and sell their holdings....leading to lower prices triggering more selling. We've seen this movie many times. Buy high sell low.:

 In the week to June 26, $5.57 billion left emerging-market bond funds, the largest weekly exodus on record and the fifth consecutive week of net outflows after almost a year of uninterrupted inflows, according to fund tracker EPFR Global.

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