Emerging market bonds have been blighted by myths, but are full of opportunities.
News reports on emerging economies can end up veering between extremes, and markets can be similarly oversensitive in buying and selling emerging market corporate debt.
In some ways, this is understandable, as growth rates tend to be higher than in developed markets, and recessions to be deeper. But it can also encourage investors to shy away from exposure to emerging market debt more broadly, and all the more so when the job of fully understanding companies takes longer.
Part of the reason for this, according to Polina Kurdyavko of BlueBay Asset Management, who manages the emerging market debt segment of the new St. James’s Place Strategic Income fund, is simply the relative immaturity of the markets in which they are based; which often means companies are less transparent and that buyers and sellers of a company’s debt are harder to come by – making pricing far less efficient. This is especially true of high-yield credit, the high-return bond sector in which Kurdyavko invests. Corporate culture can present challenges too.
“In emerging market high-yield corporate credit in particular, companies are often smaller, with simpler, less leveraged capital structures, and historically a large proportion have been family-owned,” says Kurdyavko.
“That makes it harder to obtain accurate and timely information. But the biggest differentiator is these companies’ sensitivity to the global macroeconomic backdrop as well as the political and geopolitical environment,” says Kurdyavko.
Thus, unlike in developed markets, the relationship between a company and its home country requires a great deal of analysis when investing in corporate bonds in emerging markets. In general, Kurdyavko argues, there are “significantly more moving parts” in emerging markets than in developed markets, and this means that research needs to go much deeper.
Debt and defaults
For those who fail to do due diligence, it can be easy to treat all emerging market credits as much the same – the risk of default in a few is then perceived as a systemic risk to all. In reality, Kurdyavko and her team have found that companies are often in a stronger position than the market implies – moreover, there is far more variety between different emerging market companies than market trends imply.
“Emerging market corporates tend to have borrowed less than similar-rated credits [i.e. equivalent companies] in developed markets,” she says. “We believe emerging market corporates have tended to act prudently in managing their businesses – managing their liabilities, cutting capital expenditure and ensuring liquidity provision [i.e. access to cash]. This has put them in a good position to navigate uncertainty.”
Compare this, she argues, to the world of developed market companies, which have recently been rushing to please their shareholders, even when it harms their credit rating. This difference is crucial, says Kurdyavko, when considering the likelihood of serial defaults in emerging markets, because 2015 has seen many companies in emerging markets buying back their dollar-denominated debt and issuing in local currency instead.
“This somewhat mitigates the risk of a mismatch between having debt in dollars and revenues in local currency, as does the fact that a large proportion of the credits issued by companies in which we can invest have hedges in place,” says Kurdyavko. “Therefore, while we believe defaults could increase, the general liquidity profile across these companies means we will see a gradual increase from a small base, rather than a sudden spike in defaults.”
Having done their homework on default risk, Kurdyavko and her team are confident that there are good opportunities in emerging market corporate debt, despite the growth challenges faced by some emerging market economies.
“Given the smaller dedicated buyer base, the difference in performance between credits is significantly higher, especially when most investors are avoiding risk and when volatility is high,” says Kurdyavko. “These are the times in which we find fundamentally good credits being sold off indiscriminately – as well as the weaker credits. We can then take advantage of these mispricings and buy the credits we believe in at attractive levels.”
Among these opportunities, Kurdyavko is especially positive on utilities and telecommunications, thanks to their “stable and defensive” characteristics during periods of volatility. She also has regional weightings.
“We like Mexico, as it has proved more immune to negative headlines recently, and should also benefit from closer ties to the US economy,” she says.
Polina Kurdyavko is a manager of the Strategic Income fund. The opinions expressed are those of Polina Kurdyavko and are subject to market or economic changes. This material is for information only and is not a recommendation or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or by St. James’s Place Wealth Management.
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