February 2018

Portfolio Manager
Interview

Frontier market bonds

“There is currently only one hard currency benchmark for frontier
bonds: the JP Morgan NEXGEM Index. However, we believe that
opportunities exist more broadly across the asset class for active
managers of frontier market bonds.”
Brett Diment
Head of Global Emerging Market Debt

Key Points
We believe:
• Frontier market bonds offer a broad opportunity set
• Growth has picked up in a number of frontier economies
• Bonds issued by frontier nations have low correlations to
developed market bonds, offering the potential for diversification
Egypt and Nigeria, we’ve been seeing better growth recently, and
overall most frontier economies are rebounding from several years
of low growth. Looking ahead, growth prospects are generally
healthy for a broad number of countries, as shown in Chart 2 on the
following page.
Chart 1: Frontier market by market capitalization: $703 billion

• A weaker U.S. dollar has helped stabilize frontier currencies 700 25%

How do you define frontier bond markets? 600

20%
There is currently only one hard currency benchmark for frontier
500
bonds: the JP Morgan NEXGEM Index. However, we believe that 15%
opportunities exist more broadly across the asset class for active 400
managers of frontier market bonds. These include hard-currency 300 10%
government bonds issued by NEXGEM constituents, issues from
200
frontier market countries that are not part of the index due to being 5%
smaller or inaugural issues, local-currency government bonds from 100
frontier market countries, hard- and local-currency corporate bonds 0 0%
2001

2003

2005

2007

2009

2011

2013

2015

2017

from frontier market issuers, and investment-grade frontier market

issues. Because we aren’t constrained by a benchmark, we have the EMBI Global Div. Market Cap. ($bn) NEXGEM Market Cap. ($bn)
freedom to seek out what we believe are the most attractive of this EMBI Global Div. Market Cap. ($bn)
expanded range of investment opportunities. Source: JP Morgan, December 31, 2017. For illustrative purposes only.

How are frontier bond markets faring so far this year?

In our view, they’re generally performing very well. As shown below
in Chart 1, frontier bonds have grown quite a bit in terms of market
capitalization in recent years. Of course, frontier economies don’t
have an aggregate measure of growth, and there aren’t indices that
track their results. You have to look country by country. In Ghana,

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“U.S. President Trump’s policy priorities, particularly the

tax cuts that were approved in late 2017, are expected
to provide a modest boost for U.S. growth, adding to
an already improving global growth outlook.”

What effects do you think the normalization efforts of developed-
market central banks will have on the frontier bond markets?
It will most likely have a limited impact. Frontier bonds have a much
lower correlation to developed market bonds. Furthermore, issuers
typically go to the bond markets with a bond issue once per year, if
that, and most issues have shorter durations of around five or ten
years. Therefore, there isn’t as much duration risk or interest-rate
sensitivity, so policy tightening by developed-markets central banks
will have less of an effect on frontier market bond prices that it would
on bonds in developed or emerging markets.
Are you worried about liquidity in frontier bond markets?
This isn’t really an issue for us either. It’s not a problem at all in
U.S.-dollar issues, local-currency bonds are different, and liquidity
will vary from country to country. In our strategy, we invest in both
hard- and local-currency bonds, as well as a handful of frontier
corporate bonds. For local currency, we have very limited exposure
to liquidity risk.
Will the fate of the Trump agenda have an impact of frontier bonds?
U.S. President Trump’s policy priorities, particularly the tax cuts that
were approved in late 2017, are expected to provide a modest boost
for U.S. growth, adding to an already improving global growth
outlook. This is helping to offset concerns about further monetary
tightening by the U.S. Federal Reserve (Fed), which in turn has been
supportive for emerging-market assets heading into 2018. Frontier
bonds should continue to benefit in this environment. Trade is
another key U.S. policy initiative, but all of the attention has been
directed to Mexico and China. The risk of a reduction in foreign aid
would potentially have more of an impact for frontier countries;
however, this has not featured in policy discussions at this stage.
How about other risks, such as the possibility of slower growth
in China, or default risk?
Neither of these are currently viewed as risks to our views on frontier
market bonds.
What do you believe are some of best opportunities right now
in frontier bonds?
We’re seeing attractive opportunities in local market bonds, where
we’ve been adding risk over the past year. A weaker U.S. dollar has
been a huge help, as it has led to currency stabilization and attractive
carry. There are quite a few frontier countries that have compelling
local-currency bond yields. In Egypt, local-currency treasury bills are
yielding over 17%, Ghana bonds remain attractive with yields at 16%,
while Nigeria has become investable again after the long-awaited

Chart 2: International Monetary Fund forecast gross domestic product (GDP) growth (%)

16
14
12
10
8
6
4
2
0
-2
-4
-6
-8
-10
Mozambique
Mongolia
Uganda
Rwanda
Ethiopia
Bangladesh
Côte d'Ivoire
Tanzania
Kenya
Senegal

Papua New Guinea

Republic of Congo

Angola
Vietnam
Egypt
Pakistan
Georgia
Ghana
Sri Lanka
Cameroon
Emerging markets
Dominican Republic
Gabon
Morocco
Zambia
Nicaragua
Tunisia
Ukraine
Guatemala
Armenia
Serbia
Costa Rica
Honduras

Namibia
Bolivia
Fiji

Argentina
Jordan
Lebanon
Suriname
Jamaica

Croatia
Belarus
El Salvador
Belize
Nigeria
Developed markets
Iraq
Ecuador

Barbados
Venezuela
Paraguay

2022 2017
Estimates are offered as opinion and are not reflective of potential performance. Estimates are not guaranteed and actual events or results may differ
materially. For illustrative purposes only. Source: IMF, WEO, April 2017.
 Portfolio Manager Interview 03 of 04

“We’re seeing attractive opportunities

in the local market, both in terms of
nominal and real rates.”

currency adjustment, with yields in the region of 13%-15%. We also and Nigeria will be the largest issuers, but the new supply should be
see good value in Sri Lanka and the Dominican Republic, with yields easily absorbed. Overall, we are optimistic about investment
in the range of 8-10%. opportunities in frontier-market bonds, provided that investors are
selective, savvy about the markets in which they invest, and conduct
What is your outlook for frontier bond markets? in-depth research before making any of their investments.
We believe market conditions are conducive toward good returns.
First, there are no signs of reversal for the U.S. dollar. Second,
investors are still searching for higher-yielding opportunities within a
mostly low-yield environment, and frontier-market bonds offer some
good value in this space. Third, frontier-market bonds have low
duration risk, with duration of around 3.4 years, so they aren’t as
exposed to risks posed by a rising rate environment. Finally, the
technical factors are supportive of this asset class. Egypt, Ecuador

Chart 3: Frontier market bond yields are higher than core EM

10
9
8 6.32
7 6.09
6 5.32 5.04
5
4
3
2
1
0 EM Local Currency EM Hard Currency EM Hard Currency Frontier Market
Sovereign Sovereign Corporate Sovereign
EM Local Currency Sovereign = GBI-EM Global Diversified, EM Hard Currency = EMBI Global Diversified, EM Hard Currency Corporates = CEMBI Broad
Diversified, Frontier Markets = NEXGEM. Indexes are unmanaged and have been provided for comparison purposes only. No fees or expenses are
reflected. Individuals cannot invest directly in an index. Source: JP Morgan, December 31, 2017. For illustrative purposes only.

Chart 4: Frontier markets have produced solid risk-adjusted returns

Benchmark annualized returns

10 Frontier Bonds
9 US Equities
US High Yield
8 EM HC Sovereign
7 US IG Corporates EM Corporates
USD (%)

6
5
4 US Treasury EM LC Sovereign
3 EM Equities
2
1
0 0 5 10 15 20 25
Annualized volatility (%)
Benchmarks used: US Treasury = JPM GBI US, US IG Corporate = JPM JULI, EM Corporate = JPM CEMBI BD, US High Yield = JPM US HY, EM HC Sovereign
= JPM EMBI GD, EM LC Sovereign = JPM GBI-EM GD, EM Frontier = JPM NEXGEM, US Equities = S&P 500, EM Equities = EM Free. Past performance is not
a guide to future results. Source: JP Morgan, December 31, 2017. For illustrative purposes only. For definitions of each index, please see page 4.
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