(Bloomberg) -- Investors who piled into some of the world’s riskiest bonds to escape near-zero interest rates got a reality check on Wednesday when Mongolia sent its debt plunging by sounding the alarm on its economic crisis.
The government’s $1 billion of notes due in six years tumbled the most on record after the finance minister went on television to say his critical goal was to avoid default as growth slows and the debt burden soars. Barclays Plc removed its overweight recommendation on the nation’s bonds, which have offered some of the highest returns in a rally fueled by accommodative policies in the developed world.
After cash poured into debt funds tracking emerging nations at the fastest pace on record last month, the shock to Mongolia’s bond market highlights the dangers of plowing into junk-rated credits. Money managers have turned to more exotic issuers like Mongolia to take advantage of yields more than 400 basis points above the average rate for sovereigns in developing countries.
“Central bank policy has given investors a license to move down the risk spectrum,” Gregory Saichin, who helps manage $2.4 billion, including Mongolian bonds, as chief investment officer for developing-world fixed-income at Allianz Global Investors. “The risks are there. People shouldn’t come into a story like this and say they didn’t know about it.”
Finance Minister Choijilsuren Battogtokh spooked investors with forecasts that Mongolia’s ratio of government debt to gross domestic product will reach 78 percent this year, compared with a budget target of 55 percent. Yields on bonds maturing in December 2022, rated five steps below investment grade, surged 129 basis points to 8.42 percent on Wednesday, the highest since July 1.
Mongolia sold $1.5 billion in sovereign debt in 2012, known as Chinggis Bonds, largely to finance road projects across the country, with $500 million due in 2018 and the rest in 2022. Pictet & Cie., UBS Fund Management SA and BlackRock Advisors LLC are among the biggest holders of the country’s securities, according to data compiled by Bloomberg.
The country has suffered from falling commodity prices and an economic slowdown in China. Choijilsuren’s comments come six weeks after the Mongolian People’s Party trounced the Democratic Party in June elections.
"We do not believe the government wants to default or restructure," said Avanti Save, a credit strategist at Barclays in Singapore, who cut the rating on the country’s notes to market weight after the finance minister’s comments. "The government is engaging in some kitchen-sinking, announcing all possible bad news at once."
The selloff coincided with a bond rally worldwide as investors bet the Federal Reserve is in no rush to boost interest rates. Emerging-market sovereign debt has returned 6.1 percent in the past 10 weeks as investors added about $14 billion to exchange-traded funds that buy stocks and bonds, bringing this year’s inflows to a record $15.3 billion, according to data compiled by Bloomberg.
Inflows will probably continue as rates in the major economies are still set to stay lower for longer, according to Andrew Macfarlane, an emerging-markets credit strategist at BNP Paribas SA in London.
“Stories like Mongolia will clearly make investors think twice,” he said. “The technicals are so strong right now that idiosyncratic stories will not force investors to change their overall strategy.”
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