Emerging markets corporates: „No free lunch, but a good lunch“

Emerging markets (EM) are increasingly maturing into truly emancipated states. Whereas in the past they were almost ‘pawns’ in negotiations with large Western nations, today they often meet their developed peers as equals. Numerous emerging markets, as this heterogeneous entity is still called, have a choice as to which agreements or investments they conclude or accept and on what terms, due to their increasing economic strength. This gives rise to important middle powers and so-called ‘connector countries’. The latter act as links when it comes to reshaping global supply chains. For example, countries such as Mexico, Morocco and Vietnam are the winners of these developments, as they have managed to obtain higher direct investments (FDI, Foreign Direct Investment) from both China and the old world.

Countries such as India, Saudi Arabia, Brazil and Indonesia are also establishing themselves as middle powers by focussing on their own economic advantages and refusing to identify politically with any world power. India is a significant example. What is now the world's most populous country buys raw materials from Russia, and yet continues to be regarded as a democratic partner by the West. Similarly, Saudi Arabia, for example, no longer follows US wishes when it comes to oil production, while both parties nevertheless wish to conclude a security pact. In general, these new middle powers are benefiting from the geopolitical realities.

For investors globally, the emerging markets universe is therefore more relevant than it used to be. EMs are also increasingly becoming an interesting alternative for market participants seeking to avoid concentration risk in the US or Europe. For some time now, professional investors have been stepping up their investments in emerging markets. Nevertheless, net inflows into corporate bonds from emerging market issuers are still showing a negative trend this year. Despite this, credit spreads have narrowed to historic lows at times, and the performance of EM corporates in hard currencies has been just under double digits in both 2023 and this year to-date, which is decidedly positive. Accordingly, inflows should slowly accelerate.

The development of EM into a mature asset class is underlined by other facts. For example, emerging economies (excluding China) are set to overtake advanced economies in terms of purchasing power-adjusted economic output for the first time next year. Local companies are increasingly benefiting from broadly diversified financing options. Over the past few years, local bank loans, or bonds in local currency, have been just as available as USD bonds in many emerging markets – this means that companies can choose whichever option is more favourable for them, and this flexibility promotes robustness. Meanwhile, China is competing with the West at state level and, to some extent, at the corporate level, gaining influence through economic realpolitik (loans or foreign aid).

After a consolidation phase from 2021 to 2023 with a shrinking investment universe, we currently see tailwinds for EM corporates. Strong fundamentals, better fiscal data than the West, improved credit quality, an earlier start to the interest rate reduction cycle, and low default rates are just some of the arguments in favour of a positive assessment. In addition, this is supported by the current US Federal Reverse policy. Without neglecting risks, such as a firmer US dollar or geopolitical tensions, EM corporate bonds are an asset class that deserves more investor attention. And it remains the case that emerging market bonds offer more yield for less corporate risk. As such, our current assessment of the EM corporates market is: No free lunch, but a good lunch.