Emerging winners

How to avoid the emerging-market bond trap

Some investment problems are easy to predict. For example, foreign money that funds trade deficits is an invitation to trouble, whenever the fund flow dries up. That consideration is highly relevant now, after a 39 per cent increase in emerging-market sovereign and agency bond issues to $68 billion in the first half of 2014 from the same period last year, according to Thomson Reuters figures.

Investors can shift fast. During the 2008 to 2009 crisis, emerging-market bond issue volume halved within a year, according to JPMorgan, while trading volume dropped by a third. The likely results of a sudden stop in funding include a squeeze on imports, a major recession, currency devaluation and loan defaults.

Such prospects should give shivers to some of today's debt buyers, such as those helping Senegal and Kenya to run current account deficits of over seven per cent of GDP in 2014, according to the International Monetary Fund. With the MSCI Emerging Markets Index up almost 12 per cent in the past year, buyers of shares might also wonder what happens when the music stops.

Wise investors will search for countries with current account surpluses, which are likely to be less affected by a funding withdrawal. A credit crunch will also affect trade flows, so countries almost solely dependent on exports of oil or other commodities may see their balance of payments deteriorate rapidly.

So who is on the list? Apart from some economies which have almost nothing to offer the world other than oil, the IMF lists 15 countries expected to run current account surpluses in both 2014 and 2015. China and Russia are on the list, but China's potential bad debt problem and Russia's political shenanigans reduce their appeal.

Uzbekistan, Kazakhstan, Vietnam and Bolivia suffer from very poor governance. Gabon and Trinidad and Tobago are highly commodity-dependent. Croatia's current account surplus derives only from its lengthy recession.

That leaves six countries that are likely to resist crisis: Malaysia, the Philippines, Nepal, Hungary, Nigeria and Zambia. They all have decent growth prospects and current account surpluses, and none is sucking in vast quantities of expensive debt capital. Investors should give them the benefit of the doubt.