By Dion Rabouin
NEW YORK (Reuters) - In their hunt for yield, some investors have been venturing into offerings as exotic as Tajikistan's sovereign bond or Iraq's first sovereign debt sale without U.S. backing in more than a decade only to find out that even those are pricey and hard to get.
Even as emerging markets bonds lost some ground in recent weeks in the secondary market, primary offers from Panamanian bank Multibank Inc
The sellers' market is good news for emerging market borrowers, giving them access to funds at rates once afforded only to "investment grade" issuers. But it could lead to mispricing of riskier assets and threaten valuations in the long-term by encouraging borrowers to cut coupons on future issues.
Right now it is forcing some funds to scale back.
Samy Muaddi, a portfolio manager of T Rowe Price's Emerging Markets Corporate Bond Fund, said he has reduced his purchases of initial bond offerings as 2017 has progressed.
“We have been more selective in our new issue participation rate for single B credit including Latin American airlines and Chinese real estate,” he said.
Fund managers prefer new issues, particularly on corporate debt or debt issued by countries without a solid repayment history, because they typically sell at a discount to the secondary market. That has not been the case recently, Muaddi said, noting that the percentage of new issues in his fund has dropped from about 20 percent of purchases to 12-15 percent.
Asset managers of dedicated emerging markets funds say the mispricing largely has been caused by "tourist" dollars rushing in from passive funds and non-specialized money managers, such as hedge funds or high-yield funds, chasing higher returns.
"It’s frustrating for me as an investor," said Josephine Shea, portfolio manager at Standish Mellon Asset Management Company LLC. "There seems to be quite a bit of indiscriminate buying without looking into underlying fundamentals."
The difference between emerging market bonds yields <.JPMEPR> and yields for U.S. Treasuries has widened over the past couple months, most recently touching 339 basis points as the U.S. dollar strengthened and local factors weighed on countries in Latin America and the Middle East.
However, that number is 35 basis points tighter than the 16-year historical average and comes after spreads compressed to their tightest in three years in mid-October.
BELOW FAIR VALUE
Shea said that recently bond deals in India and elsewhere in Asia have been 10 times oversubscribed and that the firm has had to drop out of corporate and even frontier market sovereign bond issues because the final interest rates have fallen well below the firm's assessment of fair value.
In previous years, Shea said, bonds would typically be two to four times oversubscribed.
Even when they do participate in offerings, some managers say they get less than they want because of high demand. Increasing supply would ease the crunch, but investors say the amounts are already significant for some issuers. For example, Tajikistan sold $500 million in bonds, which is a lot considering the central Asian nation's annual economic output is about $7 billion.
Jim Barrineau, head of emerging markets debt at Schroders (LON:SDR), said he has been buying "smaller, less well-known" names and boosting emerging market corporate debt, eschewing stalwarts like Brazil, Mexico and Russia. Among his additions are international telecoms company Millicom International Cellular SA (ST:MICsdb) and mobile provider Digicel Group LTD
While portfolio managers talk of "overcrowding," many still plan to boost their emerging market debt holdings, expecting inflows to keep recovering after worries about the global effects of the U.S. Federal Reserve's policy tightening kept investment subdued between 2013 and 2016.
This year, emerging market portfolio debt inflows are seen more than doubling to $242 billion from $102 billion in 2016, data from the Institute for International Finance shows. (Graphic: http://tmsnrt.rs/2AlLT2A)
"Any time you have a market that has had the type of performance that EM debt has had over last 18 months there's going to be some trepidation, but it’s important to look at fundamentals," said Arif Joshi, emerging markets debt portfolio manager at Lazard Asset Management.
Joshi noted accelerating growth, narrowing current account deficits and a shift to sounder economic policies in several emerging economies.
Similarly, Jan Dehn, head of research at Ashmore Investment Management, said he saw the recent pullback as part of a seasonal pattern and was using it to boost his positions.
"EM is still very, very attractive," Dehn said. "Our plan is to buy more."
Such optimism has prompted some managers, including T Rowe's Muaddi and Paul McNamara, investment director at GAM, to direct funds to some less volatile and more liquid emerging market issuers.
"The sheer enthusiasm with which people are throwing money at EM," said McNamara, "makes us cautious."