Concerns over high demand for EM bonds It is all very well fund managers urging you to invest in emerging market bonds, but are there enough bonds to go around? The enthusiasm with which global managers are pushing emerging market debt as an alternative to lower-yielding fixed income investments in the developed world is raising eyebrows among some specialists. There are fears that some developing countries may not be able to absorb a huge influx of money without suffering an investment bubble with potentially dire consequences. But these concerns are not stopping fund managers and others working hard to open a new frontier in the developing world. At a recent strategy roundtable, BlackRock said US institutional investors, such as pension funds, are routinely being told they should double their exposure to emerging market debt to 8 per cent from a current average of 4 per cent of their portfolios. BlackRock goes even further, recommending a 10 per cent allocation. "For investors looking to get incremental yield, it's more important than ever to cast a wider net," Russ Koesterich, BlackRock's chief investment strategist, said at a presentation in New York last week. Rock-bottom interest rates in the US and Europe have lured many investors to higher-yielding emerging market bonds in the past couple of years. Strong economic growth in the region, in contrast to the struggling developed economies, has helped persuade pension funds that the risks historically associated with emerging markets have diminished. But if they all follow BlackRock's advice to put more money to work, an extra $3tn may be funnelled into emerging market bonds in coming years, or $485bn for each percentage point increase in portfolio exposure, according to BlackRock's own calculations. That is about three times the total amount of bonds sold by emerging markets corporations and sovereigns in 2012, or $1.1tn, according to Dealogic figures. And that was a record year for the region. It is worth noting that the current total of outstanding sovereign and corporate debt from emerging market countries is only $4.9tn, according to Bank of America Merrill Lynch. I'm frequently getting calls from our hedge fund clients asking me to help them find more and more assets to buy in emerging markets. But it's not getting easier to find good options. Actually, it's getting tougher," says Alberto Bernal, head of research and strategy at Bulltick Capital Markets, which specialises in Latin American investments. Domestic bond markets have deepened considerably in places such as Mexico, Brazil, Turkey and South Africa, but their size relative to more mature markets is still small. As a result, many traders and bond managers are reluctant to part with the securities when they do get their hands on them. Prices have been squeezed higher. The demand is even higher for bonds traded internationally. Since 2010, the governments of Mongolia, Belarus, Zambia, Georgia, Bolivia, Tanzania, Paraguay, Angola, Nigeria, Albania, Montenegro, Jordan and most recently Honduras have all been able to tap global investors for bond issues for the first time. "You know there's something wrong when you see a very large pool of investors aggressively trying to buy bonds by companies with very weak balance sheets, or being sold by a country such as Bolivia, with yields below 5 per cent," Mr Bernal says. Mismatched expectations for supply and demand in emerging markets is not the only challenge investors may face this year. There may also be a mismatch in people's expectations for returns on these bonds. Marcelo Assalin, head of emerging market sovereign debt at ING US Investment Management Analysts also caution that emerging market debt is not likely to be a one-way bet, since idiosyncratic local economic conditions, government actions and other risks can all make rates and prices volatile. For example, while on a 12-month basis returns on emerging markets bonds still stand above 10 per cent, year-to-date performance is lagging behind, in part because of a recent rise in US Treasury yields, according to the JPMorgan EMBI Global Diversified Index. There may also be a mismatch in people's expectations for returns on these bonds," says Marcelo Assalin, head of emerging market sovereign debt at ING US Investment Management. The other question is whether emerging market governments and companies really need all the extra money that could come their way. One person who believes so is Doug Peterson, chief executive of rating agency Standard & Poor's, who has been travelling in the developing world to advise on the expansion of local debt markets. "Emerging market countries are developing credit cultures in order to finance schools, roads, energy and hospitals where our ratings facilitate access to more investors," he said on a recent conference call with investors in S&P's parent company, McGraw-Hill. But Alan Ruskin, a macro-strategist at Deutsche Bank, says warning signs are flashing already in Hong Kong, South Korea, Brazil, China, Thailand, Malaysia and Hungary. In Hong Kong and Brazil credit growth does not seem to have translated into strong GDP growth, suggesting the money is being put to unproductive uses. You have got to be alert. A credit boom can be one side of asset inflation and, in its worst form, an asset bubble," Mr Ruskin says. Credit booms are prone to end in a credit bust.