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Emerging corporate bonds:
enduring resilience
Q&A
Pictet Asset Management
November 2014
Alain Nsiona Defise, Head of the Emerging Corporate bond team
Emerging corporate bonds
have faced a number of stress
tests in 2014, including a
bond default in China and
shifts in US monetary policy.
In this Q&A, Alain Nsiona
Defise explains why the asset
class has proved resilient
amid the turmoil, and why it
continues to offer attractive
investment opportunities.
Economic growth in emerging markets has been
slowing considerably over the past several months. How
has this affected emerging market corporate bonds and
how might persistently sluggish world growth influence
returns next year?
AD. Compared with other emerging market securities,
emerging corporate bonds have proved resilient in a period
that has seen a number of macroeconomic shocks, such
as the “taper tantrum” sell-off in May 2013, when the US
Federal Reserve first unveiled plans to scale back monetary
stimulus. More recently, the asset class has also overcome
the first Chinese onshore bond default, a debt default
by Argentina, economic distress in Venezuela, a conflict
between Russia and Ukraine, and tensions in the Middle
East – developments that would normally have triggered a
broad-based sell-off.
We think one of the reasons behind the market’s resilience
is the stability of its investor base. Some two thirds of
emerging corporate bonds are held by institutional investors,
who tend to buy and hold, while less predictable retail
investors account for only a small percentage of the market.
This makes the asset class less vulnerable to shifts in global
investor sentiment, which can trigger short-term capital
outflows.
The large institutional investor base will continue to act as
a strong anchor for the asset class. Indeed, because of the
composition of their liabilities, institutional investors such
as pension funds will always require securities that offer
both stable income and diversification benefits. Emerging
corporate bonds, which are predominantly investment
grade, can satisfy these needs.
What is more, valuations remain attractive as emerging
market corporate bonds trade at spreads that are almost
double those of similarly-rated securities in the developed
world. And even if economic conditions remain as sluggish
as they have been in recent months, this is not necessarily
bad news for investors in the asset class. Provided growth
remains moderate and interest rates stay low, higheryielding bonds’ appeal should remain intact.
As the US economy has recovered and the Fed
has ended its quantitative easing programme, the USD
has rallied. A strong USD tends to weigh on emerging
market assets. To what extent is this true for emerging
corporate debt?
AD. A strong USD is not necessarily negative for the
companies we invest in. There are many exporters in the
market that benefit from such a currency shift. They are
those whose revenues are primarily denominated in the
USD and whose costs are in local currency. Examples
include mining companies – such as those in Brazil and
Russia – and Brazilian sugar producers. Conversely,
companies operating in industries such as the media
and telecoms, where revenues are largely generated in
local currency, could see some pressure on their balance
sheets.
On a country basis, we believe the currencies of South
Africa, Turkey, Indonesia and Brazil are more vulnerable
to a further rise in the USD. Hong Kong and Gulf
countries with pegged currencies and those with large
current account surpluses should prove resilient.
New issuance among emerging corporate
companies has grown sharply as borrowing costs
have fallen. Have credit risks in emerging market
corporate debt increased as a result?
AD. While growth in emerging economies remains
subdued, companies’ leverage levels, measured by
total debt relative to equity, have continued to be fairly
modest both in absolute terms and relative to their
developed world counterparts.
By region, the gross leverage ratio is highest in
Latin America (x3) followed by Asia (x2.8), and then
emerging Europe and the Middle East and Africa (x1.6).
These figures include quasi-sovereign issuers, whose
credit credentials are generally weaker. Excluding such
borrowers, the emerging corporate bond market’s debt
profile is even stronger.
Also, developing companies’ EBITDA (earnings before
interest, taxes, depreciation and amortisation) margins
are only just below their previous peak of around
20 per cent on average. Interest cover also remains
adequate. For these reasons, we expect the credit profile
of emerging corporate borrowers to remain stable. It
is also worth noting that the vast majority of corporate
borrowers in the emerging world – some 70 per cent –
are investment grade. That is a major change compared
to the situation just over a decade ago, when almost
two thirds of the market was speculative grade.
The US is withdrawing monetary stimulus while
other major developed central banks are doing the
opposite. How will this divergence affect the asset
class?
AD. The divergence in the monetary policy stance of
major central banks will likely keep markets volatile
in the quarters ahead. Country and company-specific
factors will add to that volatility, creating both
investment risks and opportunities.
Higher US interest rates could make it more costly for
companies to refinance existing debt and may – in some
instances – raise the risk of default. Even so, we believe
these riskier companies constitute a relatively small part
of the investible market. Most corporate borrowers are
unlikely to be affected by the fallout from tighter US
monetary policy.
And even if domestic interest rates across some
emerging markets were to rise because of accelerating
US growth and hawkish shifts in the Fed’s stance, this
should not have a major effect on emerging corporate
bonds. Because these securities are largely denominated
in the USD, they are not especially sensitive to moves in
domestic interest rates. That said, some industry sectors
might be affected by hikes in local rates, particularly
financials and real estate.
How is your portfolio positioned?
AD. We see interesting opportunities in Asia, where we
have focused investments in companies operating in the
industrial, transport and financial sectors. These firms
are concentrated in China, Indonesia and India, where
we are overweight. In the Middle East, we have found
that certain strong credits have been unjustifiably tainted
by the region's political turmoil; because of this, we have
increased our exposure to the region.
Lastly the fund retains its overweight to Mexico and Brazil.
Alain Nsiona Defise, Head of the Emerging Corporate bond team
Alain Nsiona Defise joined Pictet Asset Management in
2012 as head of the emerging corporate bond team.
Previously, Alain was at JP Morgan in London where
he managed the emerging corporate business, worth
over USD 2 billion. Prior to that, he worked for nine
years at Fortis Investments where he started as a senior
credit analyst focusing on the high yield market and
later worked as a senior emerging fixed income portfolio
manager building the emerging corporate business.
He holds an Ingenieur Commercial (Masters) from Solvay
Business School, Brussels and a Diploma in Financial
Analysis from the European Federation of Financial
Analysts Societies.
WHY PICTET ASSET MANAGEMENT FOR EMERGING
CORPORATE DEBT?
• A thorough investment process: investing successfully in
EM corporate bonds requires a deep understanding of both the
micro and macro forces at play in the market. Our process is
geared to analysing these factors in depth.
• Experienced team: the emerging credit investment team has
an average of over 15 years experience in credit research and
emerging market credit investing.
• In-depth local knowledge: within the team, dedicated EM
credit analysts perform fundamental research to identify the
strongest investment opportunities. They possess strong local
knowledge, including a thorough understanding of operational
risks and corporate governance in the markets covered.
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