Bonds and Stocks in Emerging Markets
Fewer bonds and stocks are available for purchase in emerging markets than in developed ones, but bonds and stocks are still two of the primary ways to invest in emerging markets. As an investor outside of a country, you may not be able to buy bonds and stocks directly, and the risk levels are probably higher than you’re used to. So buying bonds and stocks in emerging markets can be more complicated than buying them in developed markets — but it can also be rewarding.
A bond is a loan; the buyer gives money to the issuer, and then the issuer repays the loan over time. Each interest payment is known as a coupon, and the bond’s price at issue is known as the principal. After the bond is issued, the price will go up and down so that the realized interest is in line with the market rate of interest.
When interest rates go up, bond prices go down. When interest rates go down, bond prices go up. That relationship holds in every market in every time period.
Bonds come in two flavors:
Government bonds and sovereign debt: In many emerging-market countries, the government is the primary economic agent. One way to invest in the growth of the country’s economy is through bonds issued by the government itself, also known as sovereign debt.
For that matter, government debt is a key factor in most developed markets, too. Government bonds tend to trade in large volumes and generally have less risk than corporate bonds in the same market.
Corporate: Corporate bonds are issued by corporations to finance their growth and expansion. Many companies prefer to use debt rather than equity to expand because in many countries, interest expenses are tax-deductible. And as long as a company doesn’t go bankrupt, debt allows the current owners to stay in control. In contrast, if the company issues stock, the current owners have to share power with the new shareholders.
If a company or government can’t pay the principal or interest on its loans, the bond goes into default. With a corporate bond, the bondholders will press the company to come up with a plan to pay off the debt or to liquidate the company, but bondholders may be left with nothing after the bankruptcy process is finished. The exact process and legal remedies vary from country to country, but you stand a chance at getting some money back.
Whether the troubled bonds are issued by a corporation or a government, your first question is whether as an international investor you will be treated the same as investors who live in the country. The order of repayment in bankruptcy is known as seniority, and it’s possible that citizens are senior to outsiders.
Government bonds, on the other hand, are usually restructured. Instead of the bondholders getting nothing, they may receive new bonds, repayment at a lower rate of interest, or partial repayment. It’s not as good as full payment, but it is something.
A share of stock is partial ownership in a company. With a stock, your potential profits are unlimited. But, if the company goes bankrupt, shareholders are repaid only after all the creditors and bondholders are, so they most likely receive nothing. However, liability is limited to the size of the investment; you won’t lose more than you invested.
In many markets, overseas investors aren’t allowed to vote on corporate matters. Even if you’re able to vote, your position may be dwarfed by the shares of a controlling family or corporation. And, the less say you have in how a company is run, the less valuable your shares are.
An initial public offering (IPO) of stock is the first time that shares are sold to the public. These offerings don’t come along often, but when they do, they’re a great opportunity for investors to get in on the ground floor. IPOs are usually covered with much fanfare in the financial press, so if you stay on top of news about the markets, you’ll know about them.