- Eduardo Borensztein, Olivier Jeanne, Paolo Mauro, Jeronimo Zettelmeyer, and Marcos Chamon
- Published Date:
- January 2005
IMF researchers, in collaboration with the Emerging Markets Traders Association (EMTA) and the Emerging Markets Creditors Association (EMCA), conducted a survey study of market participants’ attitudes toward innovation in emerging markets’ debt instruments. The survey focused on growth-linked bonds, but also included questions about commodity-indexed and local-currency securities. The survey was distributed among the members of EMTA and EMCA, thus reaching a broad range of bond market participants, including participants from both the “buy side,” such as asset managers and proprietary trading desk managers, and the “sell side,” such as research strategists and analysts, as well as both “crossover” investors, who hold emerging market bonds only occasionally, in response to perceived profit opportunities, and emerging-market-dedicated investors.
Sample and Distribution Method
A link to the web-based survey was distributed via e-mail by EMTA and EMCA intermediaries to about 1,000 potential respondents at EMTA and 30 at EMCA, indicating that it had been designed by IMF researchers, who would not have access to respondent names or other individual information. Individual passwords allowed each respondent to fill out the survey only once.1 An option was also provided to fill out the survey and return it via e-mail or fax, and a few respondents chose to do so.
Research Strategy and Response Rate
In designing a survey of this type—to be sent without any incentives to busy financial market participants—there is a trade-off between length and the likely response rate. The design was somewhat more comprehensive and complex in both presentation of background information and seeking of potential answers. Growth-linked bonds in particular are more complicated than other existing instruments and needed to be presented clearly to financial market participants who were not familiar with them. Fewer responses based on a clearly formulated setup were considered to be preferable to more responses based on relatively limited information. Similarly, a key objective was considered to assess the relative importance of a fairly large number of potential obstacles to financial innovation.
Consequently, the number of responses turned out relatively low, at 28. This response rate should be viewed bearing in mind that the main questions covered uncharted territory and required considerable analysis by the respondents. An alternative interpretation of the low response rate is that potential respondents may have been generally dismissive of the idea of growth-linked bonds and decided that completing the survey was not worth their time. According to that interpretation, the results reported below would reflect selection bias in favor of growth-linked bonds, that is, they would provide an excessively optimistic picture of investors’ views regarding growth-linked bonds.
Respondents were asked to indicate their profession and areas of expertise, for example, buy side versus sell side, or dedicated investor versus crossover investor. Despite its small size, the set of actual respondents spans a broad range of professions and areas of expertise. In presenting the results, we highlight any systematic differences in the responses that seem to depend on the type of respondent, though such results need to be interpreted with special caution owing to the small sample size.
Overall Attitudes Toward Growth-Linked Bonds
Questions 1 and 2 sought to assess respondents’ overall attitudes toward growth-linked bonds. They presented two alternative designs for growth-linked bonds, and asked respondents to price such bonds.
Question 1 asked respondents to consider the case of an emerging market sovereign borrower (“EmergingLand,” EL) that had successfully tapped international financial markets for a number of years, was currently not experiencing major problems, but whose bonds were trading at substantial spreads above U.S. treasuries. In the example, EL had experienced real GDP growth of 3 percent on average over the past 15 years, with a maximum of 7 percent, and a minimum of negative 8 percent; and average growth and volatility of GDP could be expected to be similar in the next decade. Respondents were asked to assume that 10-year eurobonds (U.S. dollar-denominated) issued by EL (“plain vanilla bonds,” PV bonds) with a coupon of 7 percent currently trade at a spread of 400 basis points above U.S. treasuries. EL was said to be contemplating issuance of a growth-indexed bond (“Growth Bond”) with a 10-year maturity and with a coupon of 7 percent plus the difference between real GDP growth during that year and 3 percent. However, coupon payments were restricted to be non-negative:
Coupon = 7 percent + (real GDP growth–3 percent), with a minimum of zero.
Respondents were asked what premium they would require to hold a growth-linked bond rather than the plain vanilla bonds offering the same expected coupon payment. The growth-linked bond was designed to pay higher coupons in years when growth was higher than average, and lower coupons in years when growth was lower than average, with a minimum of zero. Respondents were given the following options: (1) spreads more than 50 basis points lower than PV bonds; (2) spreads 10–50 basis points lower than PV bonds; (3) same spreads as PV bonds; (4) spreads 10–50 basis points higher than PV bonds; (5) spreads 50–100 basis points higher than PV bonds; (6) spreads 100–200 basis points higher than PV bonds; (7) spreads 200–300 basis points higher than PV bonds; (8) spreads more than 300 basis points higher than PV bonds; and (9) unwilling to purchase regardless of the spreads.
As Figure A1 shows, there was a wide variety of answers: some respondents said that they would accept spreads that were lower or the same as those on PV bonds, whereas others said that they would be unwilling to purchase such bonds regardless of the spreads. The median answer was a premium of between 100 and 200 basis points. Buy-side respondents indicated somewhat higher premiums on average than sell-side respondents, as did “dedicated” emerging market investors compared to those who identified themselves as “crossover” investors.
Figure A1.Question 1: Premium over Plain Vanilla Bonds
Source: IMF staff.
Question 2 asked for the required premium when the growth-linked bond had a different specification, which ensured a minimum positive coupon payment regardless of the economic performance of the borrowing country at any given time. The yearly coupon had a minimum of 3.5 percent, and an extra payoff in years of positive growth, according to the following formula:
Coupon = 3.5 percent + real GDP growth, with a minimum of 3.5 percent.
Respondents were told that this bond carried the same expected coupon as the bond in question 1. Respondents displayed greater propensity to hold the bond in question 2, with the mean premium over a plain vanilla bond being just over 100 basis points (Figure A2). This compares with a mean of just above 150 basis points for the bond in question 1. Again, sell-side participants and crossover investors appeared more willing to hold this bond than did buy-side market participants and dedicated investors.
Figure A2.Question 2: Premium over Plain Vanilla Bonds
Source: IMF staff.
Main Obstacles to Growth-Linked Bonds
Questions 3 and 4 sought to gauge the relative importance of a number of obstacles to the introduction of growth-linked bonds or, equivalently, the sources of premiums that investors would demand to hold growth-linked bonds rather than plain vanilla bonds.
Question 3 asked respondents whether any of a set of five hypothetical changes to the status quo would lead them to reduce the premiums they required to hold growth-linked bonds. The hypothetical changes as well as the corresponding mean and median answers are reported in Table A1: 1 is very important and would lead respondents to reduce the spreads by 50 basis points or more; 2 would lead respondents to reduce the spreads by 20–50 basis points; 3 would lead respondents to reduce the spreads by 10–20 basis points; and 4 is irrelevant.
|The United States is planning to issue growth bonds at about the same time.||3.35||4|
|Five other major emerging market sovereigns are planning to issue growth bonds at about the same time.||2.95||3|
|A reliable economic consultancy firm announces it will provide free software with a formula for pricing growth bonds.||3.52||4|
|A well-respected international consortium reports a study showing that the GDP data provided by the country are reliable, and announces it will monitor GDP data quality annually.||2.78||3|
|Growth bonds covering at least 50 percent of the country’s debt are issued in the context of a negotiated restructuring of EL’s debt.||2.42||2|
As shown in Table A1, among the factors that would make respondents more willing to hold growth-linked bonds, they highlighted the issuance of a large volume of growth-linked bonds in the context of a debt restructuring operation and methods aimed at buttressing the integrity of the GDP data.
Question 4 was of a qualitative nature and asked respondents to consider which obstacles made them reluctant to hold growth-linked bonds. The potential obstacles as well as the corresponding mean and median answers are reported in Table A2: 1 is very important, 4 is not important.
|Uncertainty about future liquidity of growth bonds.||1.72||2|
|Complexity/difficulty in pricing.||2.23||2|
|Uncertainty about integrity of GDP data reported by EL.||1.73||1|
|Concern that EL will have fewer incentives to promote economic growth.||3.20||3|
|Variable coupon instead of fixed coupon.||2.91||3|
Among the factors that made investors reluctant to hold growth-linked bonds, respondents pointed most often to uncertainty about future liquidity in markets for these bonds and concerns about the integrity of GDP data that must be provided by the issuing sovereign. Those concerns were less important for dedicated emerging markets investors than they were for crossover investors. These results are consistent with the answers to question 2, and highlight the importance of both data reliability and market liquidity for potential investors in growth-linked bonds.
Question 5 sought to identify the reasons why commodity-indexed bonds have not been used more frequently. It asked respondents to consider the case of an emerging market that was heavily dependent on exports of a single commodity and sought to issue commodity-indexed bonds, that is, bonds whose return was indexed to the price of that commodity. Again, the question asked respondents to identify which potential obstacles made them reluctant to invest in commodity-indexed bonds. The potential obstacles as well as mean and median answers are reported in Table A3: 1 is very important, 4 is not important.
|It is too difficult to forecast commodity prices beyond three to five years.||2.54||3|
|You invest in many countries and only a few countries are heavily dependent on a single commodity. It is not worth your time to learn about commodity prices.||3.17||3|
|You are not interested in direct exposure to commodity price fluctuations, even if many of the countries you invest in are heavily dependent on commodities.||2.71||3|
|You are interested in exposure to commodity price fluctuations, but prefer to obtain it directly through forwards or futures linked to commodity prices.||2.36||2|
Respondents indicated that difficulties in forecasting commodity prices beyond a three-to-five-year horizon and a preference to obtain exposure to commodity prices directly through commodity derivatives made them reluctant to hold commodity-indexed bonds. In additional comments, some fund managers noted that they lacked a mandate to invest in commodities.
Finally, respondents were asked to indicate the relative weight they attached to possible obstacles to holding domestic-currency-denominated bonds.
Question 6 asked respondents to indicate which obstacles made them reluctant to invest in bonds denominated in EL’s currency. The potential obstacles as well as the corresponding mean and median answers are reported in Table A4: 1 is very important, 4 is not important.
|You are concerned about the possibility of a rise in inflation in EL.||1.91||1|
|You are concerned that EL’s central bank could intervene in foreign exchange markets and pursue an unfavorable exchange rate close to the time when bond payments are due.||2.00||2|
|You are concerned about your ability to hedge exposure to EL’s currency because of an illiquid NDF market.||2.04||2|
Thus the factors that seem to make respondents more reluctant to invest in domestic-currency bonds include concerns about exchange rate manipulation and an unexpected rise in inflation. In additional comments, some respondents also cited concerns regarding the convertibility of the domestic currency (with the Russian GKOs case being recalled) and the domestic legal jurisdiction of local currency bonds. Interestingly, crossover investors seemed more willing to invest in local-currency instruments: their responses revealed uniformly less concern with all the possible factors that were suggested as deterrents to undertaking such investment.
This protected the integrity of the survey against the possibility of a single individual providing multiple entries. The selection of passwords for individual respondents was conducted by intermediaries. This information was not available to the researchers.
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Note: For information on the titles and availability of Occasional Papers not listed, please consult the IMF’s Publications Catalog or contact IMF Publication Services.