“Something is amiss when US Treasuries become the frontier investor’s instrument of choice.”

Fixed-income investment boutique Exotix analysts Gus Chehayeb and Gabriel Sterne went to the U.S. recently to meet MENA credit-focused clients based in New York City and Connecticut.

Here’s what they reported:

“The meetings were helpful in gauging investor appetite for the region, given the heightened risk-averse sentiment of investors to EM credits recently. Set up against collapsing EM bond prices and fund outflows, sentiment was very negative towards current market conditions in EM, albeit with some important differences within the investment community.

• Some investors have been sitting on increasing quantities of Treasuries or cash in recent weeks. Something is amiss when US Treasuries become the frontier investor’s instrument of choice. A feature of the recent conjuncture is that Treasuries have become many investors’ hedge against all sorts of dark clouds on the horizon. They are a much simpler trade than shorting various combinations of European sovereigns, but as risk goes global, they have yielded highly correlated returns.

• Relatedly, some investors have become sceptical over the last 12 months that EM valuations offer good value compared with other assets, particularly compared to equity valuation metrics in some major manufacturing industries in Europe.

• But as confidence has drained, credit supply factors have come to the fore. There was concern over redemptions in some funds, a marked turnaround from earlier in the year when EM funds were still receiving inflows as concerns grew that Rome was burning while Europe’s Neros fiddled.

• Those with spare cash were becoming interested in bargain hunting, but few were in a hurry to buy with global winds blowing so forcefully in a southerly direction.

“We found that investors were most interested in discussing Dubai Holding Commercial Operations Group (DHCOG) and Dar Al- Arkan (DAAR) given the recent sell-off in both issuers’ credits (see Dar Al-Arkan: Peeking under the hood; upgrade to BUY on the 15s, 15 September 2011 and Exotix Weekly Briefing: 16 August 2011 ‘DCHOG Upgraded to Buy’ for more details). In just the last two weeks (i.e. since 19 September), for example, DHCOG’s 2017 fixed rate note has fallen almost 7 points, from a mid price of 76.8 (11.8% yield) to 70.3 (13.8% yield). Likewise, over the same period, DAAR’s 2015 fixed rate sukuk has fallen 4 points, from a mid price of 95.5 (12.4% yield) to 91.5 (14% yield). These names represent some of our top ideas in the MENA HY credit space, and in our opinion, these extreme price movements are largely due to a global risk-off trade, rather than any company-specific events.

“Most investors we spoke to agreed that both ideas looked appealing at current levels and many stated that they are currently reinvestigating both names and are in the final stages of due diligence. However, while some of the more aggressive hedge fund clients seemed keen to pick up the credits at current levels, our sense was that the typically more risk-averse long-only funds preferred to wait for potentially lower levels or for less global economic volatility and uncertainty before pulling the trigger.”

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