An increase in interest rates in the US above 5% means that investors around the world are demanding significantly higher premiums for riskier investments. For global investors, the Abrdn Frontier Markets Bond Fund is an example of a fund that offers substantial returns. Its yield is around 10% as of July 18, according to FactSet data. But these returns are associated with a higher level of risk and may not be available to all investors. Most of the assets held by the fund are concentrated in low-income economies, according to Kevin Daly, chief investment officer for emerging market debt at Abrdn. The fund is invested in Nigeria, Kenya, Iraq, Ecuador, Uzbekistan and Mozambique, among others. Daly told CNBC Pro that these countries are “by definition high yield and higher risk, but at the same time have proven to be very good investment opportunities.” What is marginal market? According to Daly, although there is no formal definition, frontier markets are typically low-income, developing countries with underdeveloped capital markets. Many only started issuing dollar bonds in the last decade or so. “Most of them are what are considered ‘suffering nations,’ given the current dollar bond yields are double-digit territory somewhere between 11% and… 14-15 %,” he said. My prediction for the year is a return of 7 to 12% for the fund. As of the end of June, we are close to 9%. Investment director for emerging market debt, Abrdn Kevin Daly The appeal of these frontier markets is twofold, according to Daly. They tend to outperform mainstream emerging markets during risk-on periods and demonstrate resilience during risk-on periods, he said. How risky is the fund? More than half of the fund is invested in bonds rated B or higher. Ratings agency Fitch defines B-rated debt issuers as “highly speculative” when “there is a significant risk of default, but there is still a limited margin of safety.” However, Daly says investing in these markets requires careful research and understanding, with the Abrdn team meeting with central bank and government officials and attending Fund meetings. International Monetary Fund (IMF) and World Bank. “There’s quite a bit of dialogue between investors and these countries,” added Daly, whose fund management team has it. He added that these countries are “upping their game and improving investor access” as a sign of their commitment to improving their credit markets. For example, following the issuance of the first Eurobond in 2019, Benin, a French-speaking West African country, began issuing monthly newsletters to better communicate with creditors. How does the fund yield 10%? Despite efforts to improve data access for investors, information gaps remain. “If you invest in these markets, you hope to tap into it,” Daly said. For example, when IMF officials expressed concern about Kenya’s debt sustainability earlier this year, Daly said he went against the consensus and kept the bonds. “I think what the Kenyans are doing is showing a determination to cut the fiscal deficit, look for alternative financing vehicles, and they’re very willing to repay that bond next year,” Daly said. Sure enough, in the weeks that followed, Kenya got fresh financing and launched financial reforms – which led to a rise in the country’s bond prices. According to Daly, Nigeria, the fund’s largest geographic region, also seems to show promising returns. In the past, the country was forced to issue debt at very high interest rates due to the lack of structural reforms by successive governments. For example, a bond issued in 2014 – when interest rates were generally low around the world – paid 14% as a coupon. However, this will change, according to Daly. “You’ve got a new president coming in, and on the first day of his presidency… they announced the removal of fuel subsidies. Fuel subsidies cost Nigeria a fortune. about 3% of GDP last year – a huge financial drain on the country. They can’t afford it,” Daly said. He added: “Nigeria has outperformed a lot, certainly at the end of May and June, thanks to these measures. Forex Risk Management Forex risk management is complex in marginal markets, where hedging tools are often ineffective or unavailable. Instead, according to Daly, the fund takes a total return approach, expecting some currencies to depreciate but with high yields to compensate. For example, Zambian debt with a 24% interest rate in the local currency, he said, could deliver double-digit returns even if the local currency weakens. In addition, debt investors often finance their purchases with dollars, euros or pounds – known in the jargon of arbitrage – which typically have lower interest rates than their investment destination. “The spreads are so high in these markets that you are looking to profit from a total return that is likely to exceed investment in dollar bonds,” he added. The outlook for the second half of the year Daly is expected to continue to be volatile in frontier markets as the aggressive Federal Reserve affects Treasury yields throughout the second half of the year. However, he said some catalysts – such as Zambia’s restructuring – could boost sentiment. “My prediction for the year is a fund return of 7 to 12 percent. As of the end of June, we’re close to 9%,” Daly said. “I’m still sticking to the 7 to 12% range. But yeah, there are going to be tough times out there.” The Fund is accessible to investors in Europe, Korea, Singapore and Taiwan through stockbrokers.