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Home > Blogs > Anthony Harrington > Is the West mispricing emerging market assets?

Is the West mispricing emerging market assets?

Finance Blogger: Anthony Harrington Anthony Harrington

While the bottom of a global recession is hardly the moment that companies in developed economies can be expected to go on a worldwide acquisition spree, there is little doubt that we will see acquisitions being made in both directions, from West to East and vice versa in the year ahead.

This raises an interesting question. Asian sovereign wealth funds, who are likely to be doing the vast bulk of the East to West buying, enjoy transparent pricing of Western assets. Granted, the pricing might not always be an accurate guide to the real value of the entity concerned, sometimes understating the value and sometimes overstating it, depending on whether the markets are exuberant or nervous. But the stock and debt price is there for all to see and the process of doing due diligence on Western companies is well understood. Switch the perspective and look from West to East and things can look rather different.

In an interesting “working paper” for the International Monetary Fund, Sonja Keller and Ashoka Mody focus on the pricing of emerging market corporate bonds and the title of their paper, “International pricing of emerging market corporate debt: Does the corporate matter?” gets right to the nub of the matter.

The question Keller and Mody set out to answer is whether all emerging market corporate debt gets tarred with a large brush labeled “emerging market,” which automatically sticks a huge risk premium on the debt, or whether the risk spread really does reflect the varying strengths of particular companies. In developed markets many analysts and lenders regard a corporate entity’s credit default swap (CDS) price as a very good indicator—for some, far stronger than a rating agency’s verdict—of a particular company’s strengths or weaknesses.

The assumption that many commentators make on Asian and emerging market corporate debt is that the “emerging markets” tag or a specific country tag will outweigh the specifics of individual corporate circumstances and performance. In fact, what Keller and Mody found was that this assumption only holds true at peak crisis moments, which is precisely when markets everywhere lose their ability to discriminate nicely between entities. Country risk, in other words, was not the key factor in valuing emerging market debt.

As Keller and Mody put it:

“The pricing of emerging market assets is thought to principally reflect changes in global sentiments and country risk. In turn, country risk is a reflection of a lack of sufficient information, agency problems (the inability of a foreign lender to monitor a distant borrower) and sovereign risk. For these reasons it is generally believed that foreign investors and lenders will tar all operations within a country with the same brush.”

The general acknowledged exceptions to this are usually companies with strong “hard currency” earnings. Keller and Mody’s “neat trick” was to switch from the usual academic exercise of examining the impact of country factors, which unsurprisingly tends to find plenty of evidence for these factors. Instead they looked at whether corporate specific factors played a role and they were rather surprised to find that they did, and in rather a large way as far as the debt markets are concerned.

There are various ways of reading this result, which seems to suggest that emerging market bond investors are getting a lot more sophisticated and finding it a lot easier to get more transparent information on target companies. It also undoubtedly means that this same increase in transparency should play well for Western acquirers looking East.

Further reading for the pricing of emerging market assets

Tags: acquisitions , Asia , corporate bonds , country risk , emerging markets , pricing
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