For the “first time in history”, according to Polina Kurdyavko, senior portfolio manager at BlueBay Asset Management, investors are being paid more for EM investment-grade corporate debt than they are for investing in any other developed market (DM) high-yield indices, in yield terms.
“We expect the asset class to deliver a positive return in 2014 based on our internally projected lower default rate – 2.1% for emerging market high-yield corporates in 2014 versus 3.1% for 2013 – and reduced volatility in US Treasury, compared with last year,” says Kurdyavko.
BlueBay is a global fixed-income investor with $58 billion in assets under management. Some $20 billion is invested in EM bonds with a third of this dedicated to EM corporate debt.
EM hard-currency corporate debt has a market capitalization of $1.3 trillion, an asset class that has tripled in the past five years and mainly consists of triple-B-rated companies. The asset class is roughly split between Asia, Europe, Middle East and Africa, and Latin America.
Even though there is a difference in duration for about one-and-a-half years between DM high-yield bonds and EM investment-grade bonds, the assumption is that this year the curve will flatten, says Kurdyavko.
“Emerging market economies are unlikely to face the same headwinds faced last year when 10-year treasury bonds sold off by 126 basis points,” she says. According to BlueBay, investors are being paid almost double the spread than their DM peers.
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Source: BlueBay presentation
EM corporates had a poor performance last year. While they outperformed EM sovereign and EM local currency debt, the asset class meaningfully underperformed DM credit indices.
Last year, the average return was -1.7% using the JPMorgan indices, underperforming DM indices by two to eight percentage points, according to Kurdyavko.
The EM volatility has opened up pockets of value this year, while corporate creditworthiness is holding steady, according to the asset manager.
Although local currency volatility and devaluation has hit certain EMs, with grim consequences, EM corporates are, to a large extent, sheltered from the fallout, says Kurdyavko.
According to BlueBay’s portfolio, a third of EM corporates are export-orientated businesses with a dollar revenue stream and thus boast a natural hedge for local FX volatility. Others tend to have some portion of foreign-exchange liabilities hedged, and those that don’t hedge tend to have a small percentage of foreign-exchange debt as overall liabilities.
“Take Chinese real estate: no companies here hedge currency but if you look at the percentage of foreign-exchange debt as a percentage of total liabilities, it is less than 20%,” says Kurdyavko. “Even if you see devaluation, it is never 100% of debt being devalued.”
The refinancing risk is also minimal. “Emerging markets have around $73 billion to refinance this year against a backdrop of flows of about $100 billion into the region and with $300 billion issuance on a yearly basis,” she says. “This number is manageable.
“Looking at asset classes as a whole, default will be driven by cyclical overleveraged names, such as sugar credits in Brazil or the coal sector in Asia, rather than currency volatility. This is partly why we expect a low default rate.”
Time of adjustment, not of crisis
Kurdyavko adds: “While there are signs of overheating in certain emerging-market economies, it is important to differentiate between a period of adjustment of risk premium for emerging-market assets and a period that is associated with crisis – like Argentina in 2002 or Russia in 1998.
“What we are witnessing today is a period of repricing of emerging-market risk assets – including emerging-market corporates – and ultimately an increase in risk premium for these assets.”
And as Kurdyavko points out, this is not to be confused with the old-style EM crisis, where you see countries defaulting on sovereign debt – which in itself is a very different environment for EM corporates.
On the back of quantitative easing that followed the global financial crisis, EMs have enjoyed a lengthy period of considerable inflows. Combined with expansion of credit, loose monetary policy and increases in corporate leverage, there has been overheating in certain EM economies.
As a result of this expansion, on average, EMs have built up foreign exchange, decreased their share of hard-currency liabilities as a percentage of GDP and have introduced more flexible FX policies.
Kurdyavko concludes: “The bad news is that, through this extended period, we have seen few structural reforms which would have enhanced productivity when the tapering debate started. Emerging-market corporates and sovereigns have seen a rapid period of adjustment.”