An anticipated 5.6 per cent in total returns expected for this year from emerging market corporate bonds could be a silver lining for fixed income investors this year, says Ms Rodica Glavan, head of emerging market corporate debt at BNY Mellon Investment Management. This is especially so, as the year had started with close-to-record low yields across many asset classes.
Even as the year started optimistically, investors have been skittish – unsettled by some events, such as the final days of Mr Donald Trump’s presidency – and rebounding on the optimism of vaccines.
Expectations of a strong fiscal package in the US have pushed growth forecasts up and, hence, interest rates higher, sending some jitters through tight credit spread markets everywhere.
Ms Glavan says: “We think emerging market (EM) corporates can withstand an increase in US Treasury yields, as long as the Federal Reserve remains accommodative and the main reason for higher core rates is stronger growth. Higher US Treasury yields have already been incorporated in the 5.6 per cent total returns expectations for this year, as attractive carry and spread compression on cyclical growth upswing more than balances out negative contribution from US Treasuries.”
She notes that with the US election over, the outcome offers positives for EMCD this year, such as a more predictable trade policy from the incoming US administration. While Ms Glavan doesn’t believe that President Joe Biden will reverse some of the protectionist policies already in place, he is likely to adopt a more cooperative approach across emerging market governments, especially China.
China is a key component of the recovery in emerging market debt and EMCD, says BNY Mellon Investment Management's emerging market debt fund manager Colm McDonagh, noting that the economy is of greater significance and influence on emerging markets than the US.
“Some 65 per cent of the increase in Chinese imports from May to December last year came from emerging markets,” he cites, pointing out that this highlights the shift in dependencies in the region.
In addition, he says: “Typically a crisis of growth in emerging markets involves a balance of payments issue – but not so this time. While there has been a significant weakening in exchange rates since the crisis began, it is not the reason for a decline in import demands.”
This is why Mr McDonagh and the BNY Mellon investment team believe companies across such regions are well-situated to bounce back from the pandemic economic crisis. While the pandemic affected the EMD universe as much as it did every asset class, and at a greater level than the 2008 crisis, he also notes the shock was less for emerging markets than for developed markets. He attributes this to lower debt levels in many emerging markets ahead of the crisis.
Defaults in EMCD last year were half the rate in US High Yield (HY) – 3.5 per cent vs 6.8 per cent – and are expected to stay below 3 per cent for this year, according to BNY Mellon Investment Management.
In comparison, according to the group’s figures, EMCD defaults reached 5.1 per cent during the difficult 2015-16 period and 10.5 per cent in the 2009 crisis.
“Moreover, and encouragingly, the EM corporate recovery rate has been at 42 per cent last year, relatively high both by historical standards and as compared with US HY, where it was at record lows of around 20 per cent,” adds Ms Glavan, citing stats from JP Morgan as at January 2021.
One of the reasons for lower default rates in the EMCD universe has been the lower net leverage across emerging market companies compared with developed market ones, for both high yield and investment grade-rated companies, she points out.
Combined with lower expected defaults is the anticipation of continued manageable issuance levels on a net basis. This is accounting for inflows back to investors from principal and interest payments, as well as tenders and buybacks of bonds by companies.
While on gross levels, emerging market corporate issuance will surpass US$500bn (approx. S$670bn) according to JP Morgan as at January 2021. On a net basis, it will be only around US$70bn, what Ms Glavan calls a very manageable amount for a US$2.5trillion asset class. Ongoing inflows into EM corporates will be an additional supporting factor from a technical standpoint.
She comments: “We believe the positive trends underpinning a long-term constructive view on emerging market corporates remains intact. These include improving corporate fundamentals, a strong tailwind from higher commodity prices and ongoing accommodative monetary policy globally, which we expect to continue.”
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