14th April 2014
Emerging market corporate debt has shrugged off everything that has been thrown at it so far this year argues fund manager Insight’s emerging market fixed income managers Rodica Glavan and Colm McDonagh.
The managers argue that there remains plenty of value to be found in emerging market debt both investment grade and high yield with the latter less sensitive to moves in the yield of US treasuries.
In a note issued today, the managers say: “There is, of course, a risk premium in EM corporate valuations relative to elsewhere in the world and the US, in particular. However, with yields likely to sit around the 7.5% mark over the next 10 years, we believe there is certainly value”.
They then consider the situation market by market.
Russia makes up 5.5% of the CEMBI Broad Diversified Index and all eyes were on the political picture in March as we witnessed a sell-off and the threat of sanctions. We had no exposure to Ukraine given the fears over its insolvency but we had exposure to Russia. This has been reduced sharply and we continue to analyse the situation. To date, sanctions have not been as stringent as first feared, the chances of a full-blown military conflict have receded slightly and there has been a more general tone of de-escalation. However, the risks have not dissipated completely. Despite there being areas of good value within Russia, we are happy to limit our exposure until the picture becomes clearer.
As far as our areas of favour are concerned, we like Brazil. It has underperformed since last summer due to the fiscal concerns that led Standard & Poor’s (S&P) to place the country on negative watch in June. Indeed, S&P downgraded Brazil last month. However, its outlook has been changed to ‘stable’ and the country has retained its investment-grade status.
Elsewhere, Argentina is also looking interesting; there has been a governmental policy shift as US quantitative easing (QE) has started to be wound down. This has been forced upon the Argentine government but its actions have been encouraging: allowing the Argentine peso to weaken, reaching an agreement with regards to Repsol and placing a greater emphasis on external politics. With the risks reduced, Argentine corporates are looking more attractive.
Central America – Mexico recovering faster than expected
In Central America, we believe Mexico is proving attractive on the basis of its faster-than-expected recovery, encouraging government policy (most notably on oil reform) and in its position as a key beneficiary of US economic strength.
Asia divergence between good and bad quality corporates
In Asia, while China is facing its own domestic economic challenges, the divergence between good and bad quality corporates is increasing – we think there is value to be found. Meanwhile, we like Indonesia and India, and the mining and TMT sectors in the latter, in particular. We are happy to retain lower exposure to Eastern Europe given the prevailing geopolitical uncertainty in the region.
The managers then set out to debunk emerging market myths.
“EM economies are not as bad as headlines tend to suggest. Indeed, from an investment perspective, we believe there are areas of real value in investment grade and high yield corporates relative to the developed markets. Year to date, despite some EM currency volatility, corporates have proven to be a lot more stable than many would have predicted.
“With lower duration, low default rates and lower volatility, we need to debunk the myth that EM corporate debt is as volatile and risky an asset class as EM equities. Quite simply, we believe it isn’t. High yield offers some of the best value across the whole fixed income spectrum, let alone just in EMs.
“There are, of course, risks. With the US winding down its QE programme, there is the threat of a spike in Treasury yields. However, while we expect Treasury yields to edge higher, we would be very surprised if there was a material shift upwards as seen last year. Meanwhile, politically it is a big year as far as the election calendar is concerned – India, Indonesia and Brazil, among others, all go to the polls. Country risk management is as important as ever, as shown by our lack of exposure to Ukraine; by avoiding the country we effectively sat out the ensuing volatility. Finally, there is the threat of a material slowdown in China but, as far as we are concerned, this would be unexpected.”