The true risk of default by many emerging markets issuers is lower than investors think, according to a report by Morgan Grenfell & Co. Ltd., London.
The so-called Brady bonds, issued by countries that recapitalized under a plan devised by former Treasury Secretary Nicholas Brady, have a nearly 50% probability of default before November 1999, based on current prices - far higher than the actual default rate on equivalent rated corporate bonds over the 1981 to 1993 period.
"To warrant such a high average default probability, one would probably need a global economic environment akin to that which prevailed in the 1930s. At present, and despite higher nominal rates in the United States, the global economic setting is not unfavorable to developing countries."
Indeed, Brady bonds may be a better bet than emerging markets equities.
"A package of Brady bonds will on average yield 16.8% to maturity, a return that easily exceeds most central estimates of emerging market equity returns over the medium term," the report said.
Developing country debt produced a negative U.S. dollar return of 14.5% in the year to date ended Oct. 31, compared with a 1.7% U.S. dollar return for global bonds as a whole.