Junk bonds of companies in emerging markets are the mostexpensive in seven years relative to the U.S., underscoringconcerns by policy makers from Mexico to the Philippines who saythe threat of asset bubbles is increasing.

Speculative-grade securities from nations including China andBrazil returned 14.8 percent since end-June, versus 9.4 percent inthe U.S., according to Bank of America Merrill Lynch indexes.Emerging-market yields fell to 7.3 percent from 9.3 percent a yearago even as net debt rose to a record 3.02 times earnings beforeinterest, taxes, depreciation and amortization, data compiled byBloomberg show. The median yield-to-leverage ratio of 2.4 compareswith 2.1 in the U.S., the smallest premium since 2005, the yearbefore developing-nation returns lagged behind.

“If global economic conditions remain sluggish, high-yieldcompanies will be at risk given their high leverage,” said BrigittePosch, an executive vice president at Newport Beach,California-based Pacific Investment Management Co., manager of theworld's largest bond fund. “Going forward being selective isextremely important.”

Investors repressed by near-zero benchmark interest rates in theU.S., the euro region and Japan are paying up for debt indeveloping nations at the same time the International Monetary Fundsays the economies will expand less than the decade average.Junk-rated companies, including Chinese property developer HopsonDevelopment Holdings Ltd., raised $18 billion last month, or 44percent above the previous record in May 2011.

Posch, whose firm manages the $285.6 billion Total Return Fund,said in a Feb. 12 e-mail that she has pared holdings of someemerging-market corporate debt with “tight valuations” the past fewmonths, while looking to add “good credits.”

When the yield-to-leverage ratio for junk borrowers in emergingmarkets fell this low versus American peers in 2005, thedeveloping-nation index returned 9.3 percent the following year,trailing the 11.8 percent gain in the U.S., Bank of America MerrillLynch indexes show.

The ratios measure how well investors are compensated relativeto the company's debt level. A higher reading indicates betterrisk-adjusted returns.

Profit Pressure

Emerging market businesses have been adding debt even as profitgrowth slows and borrowing costs stop tumbling. Ebitda at companiesin Bank of America Merrill Lynch's high-yield index increased 9.5percent in the past 12 months, less than half the 23 percent pace ayear earlier, data compiled by Bloomberg show.

“The quality of bonds issued now is lower than it was six monthsago,” Guillermo Osses, who oversees $15 billion as the head ofemerging-market debt at HSBC Asset Management in New York, said ina telephone interview on Jan. 18. “This is difficult to sustain,”said Osses, who has reduced holdings of high-yield corporatebonds.

J&F Participacoes SA, the Sao Paulo-based parent of theworld's biggest beef producer, and Schahin Oil & Gas Ltd., aBrazilian rig operator, both postponed debt sales this month asborrowing costs rose.

A growing number of policy makers have expressed concern thatcredit markets are overheating after Bank of America's gauge ofglobal junk debt jumped 115 percent in the past four years,outpacing the 91 percent total return from the MSCI All-CountryWorld Index of shares.

Funds investing in developing-nation bonds attracted $13.5billion this year, after drawing a record $97 billion in 2012,JPMorgan said in a Feb. 15 note.

The “credit booms” in emerging markets may leave them vulnerableto a reversal in capital flows once advanced-country policy makerspare back monetary stimulus, Mexican central bank Governor AgustinCarstens said in a Feb. 5 speech in Singapore.

Philippine central bank Governor Amando Tetangco said on Jan. 15in Manila that he's focused on containing speculative inflows thatmay spur asset-price bubbles. Thai central bank Governor PrasarnTrairatvorakul echoed that concern in a policy address in Bangkokon Jan. 22.

Bond Returns

U.S. Federal Reserve Governor Jeremy Stein said Feb. 7 thatinvestors' “fairly significant pattern of reaching-for-yield”doesn't “bode well” for speculative-grade debt.

Average emerging-market corporate yields have climbed 21 basispoints, or 0.21 percentage point, from a more than seven-year lowof 7.04 percent on Jan. 23. Yields for American junk bonds rose 12basis points to 6.56 percent.

Investors submitted bids for new emerging-market corporate bondslast month that were on average 10 times the amount being offered,up from four times a year earlier, Bank of America said in a Jan.31 report. High-yield sales accounted for 43 percent of the total,above the three-year average of 27 percent.

Investors have begun “to care less about whether or not a bondcompensates them appropriately and more about whether the bondcompensates them at all,” Chris Hays and Oleg Melentyev, NewYork-based strategists at Bank of America, wrote in the report.

The Washington-based IMF cut its 2013 growth forecast fordeveloping nations to 5.5 percent on Jan. 23 from a previousestimate of 5.6 percent. While that's slower than their averagegrowth rate of 6.6 percent during the past decade, it's stillfaster than the 1.4 percent pace projected for advancednations.

Emerging market companies are borrowing to finance expansionopportunities and yields are high enough to compensate investorsfor the risk of a selloff in global debt markets, said PhilipMeier, an emerging-market money manager at DWS Investments, whichoversees 283 billion euros ($378 billion).

“Investors are still keen on adding emerging markets corporatesexposure,” said Meier. “We expect the emerging markets discount tonarrow further in a positive market environment in 2013.”

Hopson Development, a Beijing-based property developer thatincreased net debt to 14 times Ebitda as of June from 4.1 times ayear earlier, sold $300 million of five-year notes on Jan. 9.

The securities, rated CCC+ by S&P, or seven steps belowinvestment grade, were priced to yield 9.875 percent. That comparedwith 10.2 percent for similar-rated bonds globally and an average15.5 percent for emerging markets, data compiled by Bloomberg andBank of America show. The bonds have lost about 2.1 percent.

Gol Linhas Aereas Inteligentes SA, Brazil's second-largestcarrier, sold $200 million of 10-year bonds on Feb. 7 with an 11percent yield. The debt, rated B- by S&P, has slipped to 98.5cents on the dollar from an issue price of 98.51.

The airline is cutting flights, firing workers and seeking torenegotiate covenants on local securities after losses in five ofthe past six quarters. Adjusted net debt climbed to 14.3 timestrailing 12-month earnings before interest, taxes, depreciation,amortization and rent in the third quarter from 6.7 times a yearearlier, the company said on Nov. 13.

“When you see massive credit issuance, it comes hand in handwith the slippage of underwriting standards,” said Michael Shaoul,the chairman of New York-based Marketfield Asset Management, whose$6.1 billion MainStay Marketfield Fund has outperformed 96 percentof peers the past five years. “The class of 2013, 2012, 2011 willhave much worse credit conditions than we are used to.”

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