Momentum swings in favour of emerging market debt
The sector will leave other types of bonds trailing in its wake over the coming years, according to Enzo Puntillo, head of fixed income at Swiss & Global Asset Management.
By Enzo Puntillo, Swiss & Global Asset Management
Friday October 05, 2012
The emerging market crises in the 1990s prompted a decade of reforms that have paved the way for a remarkable evolution in recent years.
Today, emerging markets show better macroeconomic fundamentals than many developed countries, including superior fiscal balances and lower public debt.
Over the past decade, many emerging market governments increased investment in key sectors and allowed private investment in formerly state-owned companies. As a result, their economies are now driven by a combination of both investment and consumer growth.
Indeed, emerging markets have become the undisputed driver of global growth. For decades to come, growth rates in emerging markets are likely to outpace those in the developed world.
This growth will be driven by healthy demographics and a growing workforce, an emerging middle class of consumers, growth in productivity and the development of financial systems.
As a direct result of these improving fundamentals, emerging market corporate bonds have moved into investors’ focus in recent years.
Emerging market corporate bonds have generated cumulative total returns of 113 per cent since the beginning of the recession in autumn 2008, solidly outperforming other global bond asset classes.
It is no surprise that the cyclical and secular outlook for many emerging market assets looks more attractive than ever.
Performance of emerging market debt funds since October 2008
Source: FE Analytics
The emerging market corporate bond market has improved tremendously in size and depth in recent years. This progress is the result of a combination of the change in governments’ growth policies as well as the trend towards diversifying portfolios into emerging market assets.
Today, the emerging market corporate bond market is a fast-growing asset class with a size of approximately $1trn, roughly the size of the US high-yield market.
The corporate-bond market comprises 38 countries and is well diversified regionally among Latin America, eastern Europe, the Middle East, Africa and Asia.
The Brazilian corporate debt market is by far the largest, followed by Russia, Hong Kong and China.
There are several attractive investment opportunities in many sectors such as infrastructure, oil and gas, utilities, telecommunications, real estate, metals and mining, agriculture and banking.
The quality of assets has undergone a remarkable improvement; today more than three-quarters of the market is investment grade and has an average credit rating of BBB+.
On average, corporate bonds in emerging markets offer a spread pick-up of 135 basis points compared with similarly rated US corporate bonds at the end of September 2012.
In addition, the companies in emerging markets enjoy a lower net leverage across the rating scale compared with their US counterparts.
Furthermore, over the last decade emerging market corporates have benefited from a better upgrade-downgrade ratio and a lower default rate than companies in the US.
Bond investors should consider these diversification benefits resulting from the inclusion of emerging market bonds in their portfolio.
Enzo Puntillo is head of fixed income at Swiss & Global Asset Management. The views expressed here are his own.