Yield-Hungry Investors Follow Their Appetites to Egypt
By Ira Iosebashvili
One of the most popular emerging-market trades is in a Middle Eastern currency that was shunned by investors just a year ago.
Large bond-fund managers such as T. Rowe Price Group Inc. and J.P. Morgan Chase & Co. and other investors have poured money into Egyptian government debt this year, following a sharp drop in the Egyptian pound that made the debt more attractive to foreign buyers. About 60% of the 70 local-currency bond funds tracked by data group eVestment held Egyptian debt at the end of the third quarter.
A buyer of government bonds denominated in the Egyptian pound can collect around 18% annually on the country's three-month Treasury bill as of late last week, due to moves by Egypt's central bank, which has increased interest rates sharply over the past year. By comparison, the yield on a three-month U.S. Treasury bill was 1.225%, as of Friday.
The country's cash-hungry central bank has long guaranteed that portfolio managers would be able to withdraw their money at will, allaying a key concern faced by players in smaller, less liquid markets, where it can be difficult for foreign investors to convert their money back into their original currency.
The rush to own Egypt's bonds, rated six notches below investment grade by Moody's Investors Service, shows how far investors will go to harvest returns in a world where yields in developed markets remain near historic lows. This year has seen money managers pile into the debt of countries where both payouts and risk are comparatively high, including Argentina, the Czech Republic and Tajikistan.
"Egypt is one of those idiosyncratic stories that everyone is very desperate for these days," said Denise Prime, co-manager of the emerging-market bond portfolio at GAM UK Ltd. Her fund holds Egypt's debt, which it purchased at the beginning of 2017.
But some investors fear the trade could also reverse suddenly for a variety of reasons, including any rise in political instability, faster than expected tightening by major central banks that could make the debt of emerging countries less appealing, or other developments that could dent appetite for risky investments.
Because Egyptian bonds are thinly traded, any bad news that causes many investors to sell at once could overwhelm the market and cause prices to plunge.
"The trade is a little bit exhausted," said Jan Dehn, head of research at Ashmore Group, which owned Egypt's local currency bonds earlier this year. "I think it's on its last legs." Mr. Dehn wouldn't say whether his firm still had a position in the bonds.
While high yields have attracted foreign investment, they also crimp borrowing and stifle growth. The central bank may soon need to start cutting borrowing costs to keep the economy humming.
Some money managers have been happy to take profits. Jim Barrineau, co-head of emerging-market debt at Schroders, said concerns over high inflation pushed him recently to sell Egyptian local currency bonds his firm had invested in earlier this year. Inflation stood above 30% at the end of October.
"It was a very good trade," Mr. Barrineau said. "Better to sell now than...when everyone is trying to get out at once."
Investors began eyeing the pound after the currency plummeted 50% after Egypt's central bank in November 2016 scrapped a peg of 8.8 pounds to the U.S. dollar ahead of a $12 billion loan from the International Monetary Fund.
To support the pound and combat inflation, the central bank has raised key interest rates by seven percentage points over the past year, making Egypt's local debt more attractive to yield-hungry foreign money managers.
The country's newly flexible exchange rate, fiscal deficit reductions and other changes won praise from the IMF, which has already disbursed two tranches of its loan, totaling some $4 billion.
Egypt's improving macroeconomic fundamentals and sky-high rates made it a tempting proposition for money managers. Foreign capital flows to Egypt hit a record high of $21.1 billion in the first half of this year -- compared with $7.4 billion in the first half of 2016, data from the Institute of International Finance show.
S&P Global Ratings on Friday revised its outlook on Egypt to positive from stable, citing a strengthening economy and the country's growing foreign exchange reserves, which rose to $36.7 billion in October from $19 billion a year ago.
Many investors have taken comfort in the central bank's guarantee to exchange Egyptian pounds for foreign currency for investors looking to cash out, regardless of liquidity conditions.
Persistent dollar shortages in past years have occasionally made it difficult for money managers to repatriate profits from the country. Egyptian officials have kept the guarantee in place despite an IMF recommendation to phase out the program, as it plays an important role in attracting foreign capital, the IMF said in a report.
"One of the things we wanted to know was whether we can get our dollars back," said Colm McDonagh, head of emerging-markets fixed income at U.K.-based Insight Investment. He said his firm holds Egyptian bonds, which it purchased in February.
In its report, S&P Global Ratings said the repatriation mechanism, which has been in place since the early 2000s, "offers the guarantee of capital repatriation to foreign investors for a small fee but, importantly, does not guarantee the exchange rate at the time of withdrawal."
Write to Ira Iosebashvili at firstname.lastname@example.org
(END) Dow Jones Newswires
November 13, 2017 08:14 ET (13:14 GMT)Copyright (c) 2017 Dow Jones & Company, Inc.