Our key marketing launch pitch is the same today as it was then: frontier bonds offer high yields and diversification benefits across a range of assets with a low correlation to US Treasuries. Over the past decade, we’ve had our share of ups and downs. Overall, though, it’s been a rewarding experience – demonstrating our ability to navigate this complex asset class and, importantly, deliver on performance.
The case for frontier bonds
Investing in a dedicated frontier fund allows you to potentially capture a range of diversification opportunities in bonds issued by companies, governments and other bodies in 40-45 countries, with the highest yields in emerging markets (EM). We believe this compares favourably to your typical EM bond fund, which will only give you around 25% exposure to frontier bonds.
We’ve always emphasised that returns on frontier bonds have typically been driven by idiosyncratic factors. This helps explain the strong performance of distressed credits this year. Another argument for investing in frontiers is their low correlation to US Treasuries. This has been notable in 2023 amid a big move in the US 10-year Treasury yield to 5% from 3.85% at the start of the year.
When we started in 2013, there was a case to be made that frontier issuance was scarce and there were only a handful of managers that had the necessary expertise to navigate the market. That narrative has shifted, as frontier issuance has increased over the past 15 years while yield curves have extended to 30 years. This was partly due to the low yields in developed markets that prompted a steady search for yield. Improving fundamentals and a growing familiarity with the asset class have also contributed to the increased appetite for frontier bonds.
Over the last few years, however, frontier issuers have largely lost market access due to high US Treasury yields. On a positive note, issuers have secured cheaper International Monetary Fund lending in the absence of commercial financing. And, aside from Kenya and Pakistan, there are no significant pending maturities due in 2024. In our view, this should mitigate default risk in the short term.
Nonetheless, we acknowledge that credit risk has deteriorated and there could be more credit events in the coming years following a limited number of historical defaults on government bonds (with five over the past three years). Nonetheless, we believe that current spreads overstate the default risk in the majority of issuers in our strategy.
What’s the outlook for frontier bonds?
The term ‘frontier markets’ is unlikely to shed the view that these are high-risk countries. However, we’ve sought to push back on that perception by emphasising the elevated political and economic risks in mainstream EM markets. Furthermore, we would add that investors in frontier markets are compensated for the so-called higher risks by the elevated yields on offer.
That’s not to downplay the risks. As we previously stated, we’re likely to see further credit events in the coming years as the fallout from the pandemic, the Russia/Ukraine war and higher-for-longer interest rates take their toll.
Since 2020, we’ve seen government defaults in Zambia, Belize, Suriname, Sri Lanka and Ghana. That said, there have also been defaults in non-frontier-market countries, such as Ecuador, Argentina and Lebanon. But additional credit events should not deter investors in frontier markets, or EM for that matter. After all, defaults have been part and parcel of the US high-yield bond market forever, yet that has not discouraged investors from allocating to the asset class.
What’s important is to find a manager with a successful track record investing in frontier markets. In particular, those that can assess the legal and investment implications of credit events. We believe abrdn is one of only a handful of managers that ticks those boxes.
The value of investments and the income from them can go down as well as up, and investors may get back less than the amount invested. Past performance is not a guide for future results.
Investing in frontier markets involves a greater risk of loss than investing in more developed markets due to, among other factors, greater political, tax, economic, foreign exchange, liquidity and regulatory risks.