Emerging market corporate debt is among the fastest growing fixed income sectors but how will this growth be sustained and what opportunities and challenges does this present?
The market is currently made up of around $1 trillion of paper – up from $500 billion six years ago – and on course to grow further.
Highlighting this speed of change, Lazard Asset Management’s Arif Joshi said the market is only two or three years off surpassing the US high yield market in terms of pure size.
Here Citywire Global has canvassed three emerging market corporate bond managers to find out what the impact of its rapid growth and relative infancy compared to other markets means for investors.
Commenting on the challenges facing this growing asset class are specialist emerging market corporate bond managers:
- Esther Chan, lead manager on the Aberdeen Global - Emerging Market Corporate Bond fund;
- Dorthe Freedsgaard Nielsen, co-manager on Swiss & Global's JB Emerging Markets Corporate Bond fund;
- Jack Deino of the Invesco Emerging Markets Corporate Bond fund.
Next - how the EM corporate experts intend to handle the heat
Dealing with the hot money tag
With a surge in interest in the sector through 2012, will the hot money flows now begin to subside?
Esther Chan: 'Given the strong returns from both EM government and corporate bonds last year it is hard to make the case for the same level of performance this year.’
‘In particular there are concerns regarding US dollar denominated emerging market debt correlation to the US treasury market and the impact if treasury yields begin to rise.'
'This is likely to affect both hard currency EM government and corporate bonds.’Dorthe Freedsgaard Nielsen: 'In relative terms, investment in EM corporate bonds should be considered in their own nature a credit investment, rather than a “pure” extension of a sovereign portfolio.’
‘Indeed, the asset class is best suited for investors who want to take credit exposure and are comfortable with corresponding levels of volatility.’
Jack Deino: 'While EM external debt will not likely generate the kinds of returns experienced in 2012, we expect a stable return of mid- single digits which is not bad we believe, in a world awash with liquidity and desperately seeking yield.’
‘We believe that when you compare these returns adjusted for risk investors are finally taking a view we have long held: Emerging Markets of 2013 resemble very little what they did in 2001.’
Next - keeping pace with US high yield
Outgrowing the US HY market
Is the market truly on track to surpass the US high yield market, what challenges or opportunities does this present?
Dorthe Freedsgaard Nielsen: ‘The EM corporate market is nearly the same size as the US High Yield (US HY) market, and it seems likely to outgrow it in the next few years.’
‘This strong growth is underpinned by several factors, such as lower leverage and higher spreads of EM companies compared to their US peers.’
‘However I think it will take longer for the depth of the EM corporate market to reach similar levels to the US HY market, given that the EM corporate market is still dominated by a small number of sectors.’
Jack Deino: ‘Improvements are not equal across emerging markets. While we have seen great strides in several countries, others remain sorely behind in this regard.
‘Given the very stark differences among these markets (accounting, politics, local banking relationships, family ties, strategic importance to a given sovereign etc.), we are observing many more value dislocations relative to more mature and homogenous markets (developed market HY and IG) as crossover money (much of it using the same process and platform to analyse an EM corporate as a US industry peer) continues to pour into our asset class in search of yield and diversification.’
Esther Chan: ‘The EM corporate market is already the fastest growing part of the EM space and some investors already view it as dedicated asset class, separate from EM government bonds. However, it will take a number of years for the market match the depth and liquidity of the USD high yield market.’
Next - what is the biggest challenge facing the sector?
Challenges for the sector
What could hold back or hinder growth in the sector?
Jack Deino: ‘In many cases, risk is being materially mispriced, especially new issues. In my opinion, this year will be about having the ability to buy out-of-favour and oversold sectors (where there are offers to lift in some decent size in secondary markets and it’s not impossible to build a material position).’
‘While we think EM corporate default rates will remain low this year, we also see the ability to avoid defaults as well as other negative credit events (“blow-ups”) as key.’
Esther Chan: ‘The biggest risk facing the asset class this year is an increase in US Treasury yields, but we expect this to be mitigated in part by the shorter duration of the asset class.’
‘As long term investors, our focus will remain on investing in companies that have a history of navigating through difficult market conditions, with strong balance sheets, good access to liquidity and flexible business models.’
Dorthe Freedsgaard Nielsen: ‘The market growth could be challenged if: the current positive fundamentals deteriorate; if a deep economic recession materialises, which results in a sudden jump in corporate defaults worldwide; and, there is a bumpy, high increase in the treasury rate.’
‘As a fund manager, the key challenge for me is to not to become overconfident and to continuously challenge and improve the quality of my investment decisions.’