The emerging markets corporate bond universe is much larger and more diverse than widely assumed. In the current market, a growth recovery in the developed world is helping emerging market corporates to generate better returns versus emerging market sovereign bonds.Strong fundamentals offered at appealing valuations versus comparable assets help make it one of the most compelling opportunities in global fixed income markets.
The argument in favour of emerging markets high yield is mostly unchanged despite softening macroeconomic growth expectations for Asia and elsewhere. Consensus expects China’s economy to grow around 7%, still a significant premium over developed markets. Brazilian growth has softened but may be nearing a cyclical low. India’s growth rate has dipped, although following the recent election there is potential for reform, which could lead to improved economic prospects. Russia’s declining growth may be sensitive to the current tension in Ukraine.
In our view, the macro picture hides the positive fundamentals of emerging markets corporate credit, which remain healthy. Emerging markets corporate bonds have returned on average 9% (BEMC) over the past year. That exceeded the 5.01% gain for local-currency debt and is below the 11.2% return of dollar-denominated government securities .
Nevertheless, the dislocation of summer 2013 will have unnerved some fixed income investors. The Fed’s proposals to taper the quantitative easing programme elevated concerns, thus leading many participants to reduce risk and caused a dislocation in prices across emerging markets. We have since seen a reversal in the subsequent outflows, which now contribute to a growing market.
Interest rate protection Emerging markets high yield may protect against rising interest rates. Emerging markets high-yield spreads remain elevated versus pre-crisis levels, a factor that has supported the market. Investors have targeted issuers carrying less leverage with more liquid balance sheets.
Turning to fundamentals, emerging markets corporates have the potential to provide a more efficient way of capturing growth than local currency and typically higher-grade sovereigns. Many carry more cash with less leverage than their developed market counterparts. This may make balance sheets less efficient, but their cash cushion offers more downside protection. Those strong fundamentals may provide protection against defaults, which is often mis-priced by markets.
Default rates remain low, but the market did see a few idiosyncratic events last year, notably OGX, the over-extended Brazilian gas and oil firm, and Mexican homebuilders that were hit by policy changes. Yet such events are less likely to repeat this year.
There are also structural changes that give cause for optimism. EM credit is a relatively new asset class, yet it has come a long way. New issuance hit records of almost $250 billion in 2013. In little less than 20 years, the EM high yield credit market is valued at the same level as the US high yield market was at the same stage. Monetary policy and QE helped accelerate the process in the years since the financial crisis.
High yield could offer better returns over the broad EM indices and their US counterparts, and against more sovereign heavy indexes. To capture that potential requires commitment, resources and expertise.
Yerlan Syzdykov is head of emerging markets, bond & high yield at Pioneer Investments
Unless otherwise stated all information and views expressed are those of Pioneer Investments as at August 18, 2014. These views are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested. The investment schemes or strategies described herein may not be registered for sale with the relevant authority in your jurisdiction.
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