Head Of North American Equities
EM corporate bonds: what happened to the apocalypse?
The emerging market (EM) corporate bond cynics have been very vocal of late. If you were to believe all the hype, an impending implosion of the market seemed all but inevitable. Yet it didn’t implode. Here, we debunk three of three popular myths about EM corporate bonds.
They’re risky and there are a lot of defaults
The risk profile for EM corporate debt is generally considered to be about the same as US high yield debt. This is in spite of the fact that most EM corporate debt is investment grade. In reality, companies in emerging markets default on their debt far less frequently than companies in the US high yield market. Indeed, the default rate for US high yield companies is expected to be around 6% this year, while for emerging market companies it is expected to be barely 1.5%. What’s more, the figure for EM defaults has exceeded 3% only once in the last 20 years, and that was at the height of the financial crisis. Back then, the default rate in US high yield was over 12%.
People also tend to have the impression that EM corporates are small, niche names. And while some are, many aren’t. Take ICICI, the largest private sector bank in India; MTN, the biggest telecoms company in Africa; or Hutchison Whampoa, the biggest port and telecoms company in the world.
The amount of debt which has been issued is a hazard in itself
People are worried about the amount of hard currency corporate debt that has emanated from emerging markets. While it has increased, the amount doesn’t look dramatic when you provide a bit of context. In Asia, external corporate debt has gone from 2% to 4% of GDP. It’s a similar story elsewhere. In Latin America, the percentage has risen from 4% to 9%; in the Middle East and Africa, from 4% to just 7%. These are very manageable numbers – meaning that even if they suffered a complete lockdown in external financing (an unlikely scenario), the impact should be contained.
The ‘technicals’ of the market are a mess
Supply and demand drives any, well-functioning, market. New issuance (i.e. supply) was only about US$240bn over the last twelve months, a figure 35% lower than the previous year. Money coming back into the market through interest and amortisation was close to US$200bn last year, meaning the net finance required – the amount of new bonds being issued to the market – was only about US$40bn.
While companies in developed markets have been returning excessive cash to shareholders through share buybacks and spending on mergers and acquisitions, EM companies have been using their excess cash differently. Last year we saw a record amount of bond buybacks in emerging markets: almost US$40bn. If you include that number, then the net finance required for EM corporates was close to zero. And that figure could turn negative during 2016 if year-to-date issuance is anything to go by.
The attractiveness of EM corporate debt comes from three factors. First, interest rate sensitivity is low - duration is less than five years. Second, it terms of quality it is often perceived as being akin to high yield, yet it is actually investment grade. And third, yields are north of 5.5% – a figure which is pretty hard to match from investments with a similar risk profile.
Siddharth Dahiya, Head of Emerging Market Corporate Bonds
Image credit: © Historical Picture Archive/CORBIS
Sources: JP Morgan & Bloomberg, April 2016.