EM corporate debt: from investment grade to „frontier” markets



While emerging market debt has always been a diverse asset class, it continues to expand its boundaries.

Alongside solid investment grade companies, which can be benchmarked against the best developed market peers, there are also less established – but equally as impressive – smaller companies. Some of these are from newer geographies or making their bond market debut. Together, these varied credit profiles provide emerging market debt investors with a uniquely dynamic risk/reward opportunity for their portfolios.

Togo, Ecuador and Moldova are just some of the countries from which issuers have recently joined the benchmark universe for corporate debt. The asset class continues to grow both in depth and breadth, offering investors new ways to access higher returns in a yield-starved bond universe, where globally around USD 13 trillion of debt is trading at yields below zero. Companies based in these so-called ‘frontier’ countries often pay coupons in the high single digits or even double-digit territory, providing a welcome yield boost to a well-diversified portfolio.

EM corporate debt is a young asset class, but has already outgrown major peers

In comparison to more mainstream asset classes, emerging market corporate debt is relatively young. A small core of issuers has been around for approximately 20 years, mainly from the Americas (Brazil, Argentina and Mexico) and Asia (e.g. Thailand, Indonesia and the Philippines), see exhibit 1. Since then, a steady stream of issuers from countries as diverse as South Africa, Saudi Arabia, India, China and Russia have joined, boosting the value of outstanding debt from less than USD 100 billion in 1999 to almost USD 1,500 billion in 2019, according to Bank of America Merrill Lynch data. As such, the value of outstanding debt has surpassed both the US high yield and emerging market sovereign debt segments, with the latter standing at around USD 1,000 billion, having been outgrown by its corporate peers over 10 years ago (exhibit 2).

 

Exhibit 1: EM corporate debt – an ever-increasing global reach

 


Source   Fisch Asset Management

 

Exhibit 2: Growth of EM corporates segment vs. EM sovereign debt

Source   BofAML, May 2019

 

Stronger fundamentals and better value than developed markets

On a bottom-up basis, companies based in emerging markets continue to outstrip their developed market peers. For example, they have less leverage, i.e. lower debt to EBITDA ratios (see exhibit 3). This is a highly relevant factor for investors when it comes to determining a company’s risk and resilience. Looking at the past year, the relative difference between the net leverage in US companies and emerging companies widened, in favour of the latter. At the same time, for the same unit of risk, you are paid more to be invested in a given emerging market credit vs. a given developed market credit. For example, US companies rated BBB pay a spread of 47 basis points per turn of leverage, versus 106 basis points in emerging markets (see exhibit 4).

 

Exhibit 3: Comparison of net leverage: EM vs. US corporates

Source   BofAML, December 2018

 

Exhibit 4: Spread per turn of leverage

Source   BofAML, May 2019

 

Frontier markets: strong return potential

Investors can achieve substantially higher returns, with correspondingly higher risk, via companies based in more ‘frontier’ markets. The commonalities of such issuers tend to be that they are from less developed economies and financial markets; there are no or very few existing corporate issuers in hard currency from that geography; issuance sizes are generally smaller; and ratings are lower. These bonds present meaningful return opportunities for active, nimble investors that have deep credit analysis capabilities. Examples of such issues in 2019 include a mining company in Mongolia, a telecom company in Georgia and a pan-African bank headquartered in Togo (see exhibit 5). Taken together, the inclusion of these bonds aids diversification as their performance drivers are often less correlated to global newsflow.

Exhibit 5: Examples of frontier market opportunities in 2019

Source   Fisch Asset Management

 

Strong frontier market activity in Africa

As a region, Africa has enjoyed particularly remarkable growth over the past 10 years or so, both on a sovereign and corporate level. For example, in 2010 the continent had 10 sovereign issuers, versus over 20 today. Meanwhile, eight African countries have seen their corporates borrow in US dollars. This growth is reflected in the JP Morgan blended index, which includes both sovereign and corporate names, where Africa’s share has grown from some 6% in 2014 to around 10% now (exhibit 6). Index inclusion is undoubtedly favourable, generating investor flows and, as importantly, investor understanding.

 

Exhibit 6: Africa’s index weight (%), in the blended index

Source   JP Morgan, May 2019

 

To take advantage of these opportunities, from more established emerging markets and proven companies, to frontier geographies with younger credits, investors should consider investing on a global, unconstrained basis. With best-in-class credit research, alongside an effective risk control framework, the Fisch Bond EM Corporates Opportunistic strategy seeks to fully exploit this opportunity set.

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