“Lower-rated countries are certainly worth considering and the debt fundamentals of many emerging markets are actually improving. But it is important to be aware of currency risk because the exchange rates are usually much more volatile than the underlying bonds.”
Most experts stress that sovereign ratings are only one part of the picture that government bond investors need to consider, and that the growth and inflation rates of the underlying economy, the outlook for interest rates and the policies of the central bank are just as important. Some also feel that rating agencies can be slow to react to changing debt dynamics.
Jack Kelly, investment director, global government bonds at Standard Life Investments, says: “The sovereign debt in Spain continued to be highly rated through the first few years of the crisis, even as spreads widened sharply versus Germany. As investors look to build a sovereign portfolio, they should take into account changing dynamics, even when the change takes place with the sovereign bonds coming from a fairly low ebb.”
Additionally, sovereign ratings can be of great relevance to corporate bond investors if the country is on the cusp of investment grade.
Chris Higham, manager of Aviva Investors’ Corporate Bond and Strategic Bond funds, says: “If the sovereign rating goes below investment grade it can be significant for certain mandates and result in a much higher cost of borrowing. The lower a sovereign goes, the harder it is for a corporate to maintain investment grade, so whether Spain goes below investment grade is one of the big uncertainties of this year.”
Edmund Tirbutt is a freelance journalist
