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In this edition of From the Archive, we take you back to April 1994, as Institutional Investor Senior Correspondent Kevin Muehring explores the ever-evolving investment strategy that is emerging-markets debt.


Emerging-markets Debt Comes of Age
By Kevin Muehring

Institutional Investor
April 1994

"This is emerging-markets debt trading, not LDC debt trading," chides Susan Segal. The head of Chemical Bank's emerging-markets division in New York, she is correcting a visitor's casual characterization of what she does for a living.

The semantic distinction is symbolically important. To Segal and her peers, who trade the debt of what used to be called the less developed countries, "LDC" conjures up images of all those dud loans that touched off the debt crisis, and blighted banking careers, after Mexico's default in August 1982.

"Emerging markets," by contrast, has the happy ring of solid coin, connoting fast-improving economies, dazzling profits and certain career advancement. In 1993 emerging-markets prices rose to gravity-defying levels, and trading volume doubled, to $1.5 trillion or more. Dozens of commercial, investment and universal banks responded to the surging market by pumping more capital and credit lines into their emerging-markets operations and building up their trading desks, transforming them into fully integrated capital markets operations to rival their developed-markets desks.

Then came the rout of bond markets worldwide, but especially those of emerging countries, in the wake of the Federal Reserve Board's nudging of the federal funds rate on February 4.

The damage to emerging-debt markets, while undeniable, is not likely to be lasting, however. "The growth in the market reflects the fundamental political and economic changes taking place in the world today," argues Nicolas Rohatyn, head of emerging-markets sales, trading and research at J.P. Morgan & Co. "We are moving from a world of seven currencies and interest rates to one of 47 currencies and interest rates. And despite the recent correction, that basic trend is irreversible."


Massive inflows of institutional money, particularly from yield-hungry U.S. investors, have transformed the market in just the past two years from a sideshow to the Eurobond market to a major market in its own right. "Global investors legitimized the emerging markets," says Chemical's Segal.

At one time the relevant investor base consisted of Miami-based Latin flight capital, hit-and-run hedge funds, a handful of early dedicated-country funds and the "original holder" banks that created much of the supply of debt by securitizing defaulted loans. But these players made way for scores of mostly U.S.-based mutual funds, junk bond funds and even insurance companies and pension funds lured by the emerging-debt markets' high yields, solid spread performance and capital gains. By the end of last year, such mainstream institutions held as much as 30 percent, or $172 billion, of the $425 billion in outstanding emerging-markets debt, estimates John Purcell, Salomon Brothers' head of emerging-markets research.