Articles - Focus on Emerging Market Corporate Debt

Well-funded emerging markets (EM) benefitted dramatically from the West’s financial crisis. Today EM corporate bonds have developed from a niche asset class to a globally acknowledged financing instrument. However, recent signs of slowing growth in EM geographies have called into question this asset class’ sustainability- are these concerns valid? The report explores the merit of corporate over government debt as the vehicle for EM fixed income exposure, the risks and returns through both calm and turbulent global economic periods and how best to pick the right fund structure for optimum performance.

 According to Peter Varga, Senior Fund Manager, Erste Asset Management, “The impressive development of formerly small emerging market companies has facilitated the rise of this asset class {..} Today, the market has reached a volume of about USD 1,100bn at an average yield of 6-6.5%. The almost twenty-fold increase of the market volume and the emergence of a global asset class within one decade have been facilitated by company growth as well as rapid growth on the demand side.”

 Varga emphasises the return potential of EM corporate bonds, stating that: “In contrast to the corporate bonds market, the emerging market government bond sector has shown subdued growth over the past years. This is mainly due to the very solid and low level of debt in those countries. The market volume amounts to USD 600bn, which is half the market volume of the emerging market corporate bonds issued in foreign currency.”

 Flipping the coin, asset owners explore the risks EM corporate debt may present. Günther Schiendl,
 Chief Investment Officer, VBV Pensionskasse, states: “The main risks are hot money flows, going out rapidly. And, as we are seeing in the current Federal Reserve (Fed) triggered market turmoil, it seems that investors are not fairly compensated for currency and liquidity risk.”

 Varga argues: “The problem with EM corporate debt is that you are seeing a tightening of financial conditions in emerging markets which you are not seeing in the developed markets {..} EM corporate bonds do offer reasonable value in this current economic environment, but you need to differentiate quite {…} in this current environment, you need an active manager to find reasonable value in this enormous asset class that has grown to USD 1.3 trillion, which is five times larger than European high yield.”

 Anders Schelde Chief Investment Officer, Nordea Life & Pension, Denmark, presents a slightly different take: “There may be some timing issues right now, but from a fundamental point of view, we are still trying to reach out for the beta in this asset class which we still consider to be interesting. We have challenges and risks with regards to liquidity, and also with manager selection”

 On whether recent downgrades are fundamental or related to information asymmetry Michael Kjærbye- Thygesen Senior Portfolio Manager - Fixed Income, Sampension, comments the former: “For example in Latin America, leverage for many of the companies has been increasing quite significantly which is now causing them problems when financial conditions are tightened.”

 Even though local currency issuing has become more commonplace Kjærbye- Thygesen, highlights the drawbacks of the parallel slowing growth. “Many of the corporations are issuing in USD where the revenue stream is not matched by that. In an environment where the dollar is strengthening and financial conditions are tightening, you have to consider whether these corporations are more vulnerable than the developed market corporations are.”

 On picking a relevant fund structure Ulrik Roux Wolke, Senior Portfolio Manager, PFA, shares his experiences in allocating to emerging market corporate debt. “We started out with a sovereign only EM debt portfolio and gently added more corporates as, and when, the universe has grown over the last ten years. We have grown organically along with the growth of the EM corporates universe itself, which is now close to 1 trillion USD.”

 Download the report 'Focus on Emerging Market Corporate Debt'

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