By Greg Saichin, head of emerging markets and high yield fixed income portfolio management, Pioneer Investments
July was one of the strongest months on record for flows into emerging-market debt. What are the reasons behind this drive?
These flows were driven by the search for yields with a reasonable risk profile. Emerging market (EM) securities are no longer viewed as overly risky assets as was the case in the past. They remain sensitive to economic growth and are duly affected by investors’ risk aversion when recession fears come to the fore. However, the long-running euro-debt crisis has shown the extent to which the credit standing of EM issuers has improved. Market action is telling. Over the last five years we have experienced the sub-prime crisis, followed by a recession and then the euro-debt crisis. The JPM EMBI Composite Index fell dramatically in the wake of Lehman Brothers’ collapse in 2008 and the ensuing recession but it maintained its position reasonably well during the euro-debt crisis. Throughout the period, it has outperformed not only the EMU Government Bond Index (dragged down by the performance of peripheral markets) but also the JPM Global Bond Index where traditionally the safest markets (US, Japan, Germany) account for a large proportion of the Index. These crises have prompted investors to revise their risk profiles. There was a time when EM bonds took centre stage in past crises and even sparked crises themselves. Since then, EM governments have learned many valuable lessons and have become better than many developed countries at managing their own balance sheets. Financial markets are acknowledging their efforts, even in times of market volatility.
Are EM-based companies as financially sound as EM governments?
Risk re-rating has already encompassed sovereign issuers, whose risk premiums have declined as a result, while corporate issuers are still widely viewed as somewhat less reliable in spite of the ongoing improvement in their financial management. Corporate issuers are increasingly part of the private sector and, unlike the past, have little or no relationship with governments (especially for energy-related companies). In a globally integrated world, the management teams of EM companies face similar problems to their counterparts in developed countries and have been compelled to act decisively during difficult times, such as the recession. Not all management of EM-based private- sector companies can boast the experience of their US and European counterparts. However, the risk premium paid above sovereign bonds still seems excessive and when compared to underlying fundamentals. EM corporate bonds also pay a premium over EU and US corporate with the same credit rating. The small allocation in most portfolios, also as a result of a poor representation in most benchmarks, may be a reason for this cheapness. Market benchmarks should eventually reflect the increased issuance.
Is market liquidity still a problem?
The EM corporate bond market has grown dramatically over the last 10 years and based upon data from JP Morgan Chase the total tradable amount of emerging debt outstanding is currently about US$12trn. New corporate issues have dwarfed sovereign issues since 2005 and were worth almost three times as much in 2011. This pattern has added liquidity and has provided more options for bond selection. The private sector accounts for a large part of new issuance and has contributed to sector diversification. The correlation among different sectors is quite high and can often be affected by overall risk aversion, which is not an ideal situation for true stock pickers. However, we believe that selecting well managed companies can add value to a portfolio. Our team must also assess any legal risk, stemming not only on the bond’s covenant but also from opaque solvency regimes in different countries. This may already be included in risk premiums, but it takes a specialised and we l -experienced investment management team to provide a proper assessment.
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