Emerging-markets corporate bonds on rise
As emerging-markets economies have reduced sovereign debt in recent years, the corporate bonds of such nations have taken a more prominent role in fixed-income portfolios
As emerging-markets economies have reduced sovereign debt in recent years, the corporate bonds of such nations have taken a more prominent role in fixed-income portfolios.
Continuing market liquidity improvements and strengthening credit fundamentals are helping to mitigate risks and provide the foundations for this asset class’ being an integral part of the fixed-income universe.
Nonetheless, the broadening and deepening of this asset class increases its complexity. Consequently, an integrated research approach — one that combines the disciplines of credit, sovereign debt and equity analysis — is essential to identifying potential investment opportunities.
Emerging-markets corporate bonds offer investors several distinct benefits, including an attractive yield, higher credit quality ratings relative to emerging-markets sovereign and high-yield debt, and potentially appealing returns.
Although performance history is relatively short for this asset class, over the one- and three-year periods ended Dec. 31, emerging-markets corporate debt outperformed emerging-markets sovereign hard-currency debt, global investment-grade corporate bonds and U.S. investment-grade corporate bonds.
High-yield bonds outperformed emerging-markets corporate debt during these periods, but with a higher risk profile for the three-year period.
Historically, corporate bonds in emerging markets have been clouded by perceptions of illiquidity and high risk, but these concerns are receding. In particular, liquidity has improved significantly.
The expansion of this asset class is leading to greater regional and sector diversity. In 2000, about half of new issuance in emerging-markets corporate bonds was from Latin America, but that region’s share has been reduced to one-third. At the same time, the shares of issuance from emerging Africa, Europe and the Middle East have grown significantly.
Although banks re-main the largest sector of the overall emerging-markets corporate bond market, energy and telecommunications companies have expanded their market share of late.
Over the past 18 months, emerging-markets corporate bonds particularly have benefited from favorable supply-demand trends — and that positive technical condition is expected to continue. New issuance of emerging-markets corporate debt now amply exceeds that of emerging-markets sovereign debt.
Tighter credit and withdrawal of bank lending as a result of the 2008 financial crisis has spurred more emerging-markets companies to tap international credit markets for their financing. At the same time, buoyant demand for new corporate supply has been stimulated by low interest rates in developed markets as investors hunt for yield.
That demand also has been generated by improved emerging-markets corporate credit fundamentals. The default rate of such bonds is expected to fall this year to 1.3%; the ratio of upgrades to downgrades for the whole asset class presently exceeds 1.7 times.
A distinct feature of emerging-markets corporate bonds is the composition of the yield-spread risk premium, which comprises both corporate and sovereign risk. As a result, analysis of this asset class needs to be multidisciplinary — combining credit metric analysis with fundamental macroeconomic analysis.
A third dimension is the equity perspective — the view of the issuer from a different part of the corporate capital structure. The ability to triangulate credit, sovereign and equity analyses provides a holistic view.
Additionally, given the limited transparency of emerging markets relative to developed markets, qualitative analysis — particularly in the form of face-to-face meetings with issuers — also is essential.
Skillful investors in this asset class are those able to take advantage of the sovereign-risk premium, while at the same time capturing the improving credit story.
As the global economy re-balances, emerging-markets corporate bonds are one of the best fixed-income opportunities to reflect a positive investment view on the domestic-demand recovery theme in emerging countries.
Emerging-markets corporate bonds now provide investors with a broader range of investment choices. They allow investors to express a variety of investment themes, ultimately adding diversity and value to their fixed-income portfolios.
Michael Conelius is a vice president at T. Rowe Price Group Inc. and the portfolio manager of its emerging-markets bond fund.
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