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Emerging market corporate credit comes of age

by Dylan Lobo on Dec 28, 2012 at 07:00

‘We sold an emerging market corporate credit fund to pay for this allocation, as we had become concerned over an asset class that had become very overbought, due to the intense hunt for yield, and where illiquidity could easily be an issue in challenging markets or were sentiment to change. With the yields available from emerging market corporates falling so far, we no longer felt that you were being compensated with sufficient yield to justify the risk.’

Harling, though, continues to see plenty of value in the asset class. ‘The dividend yield of emerging market equities (hedging out exchange rate risk) is actually 0% compared with the 6.2% coupon on emerging market credit. This suggests emerging market corporate debt currently offers more value than emerging market equity, given the greater security of cashflows to bondholders,’ she adds.

Meanwhile, Chan points out there is potential to exploit valuation anomalies as ratings agencies continue to give an EM risk premium to companies operating in the region.

‘Non-investment grade corporate bonds are typically issued by companies operating in countries widely regarded as safer, such as Brazil, Mexico, Russia and Indonesia, where we are very confident of the macroeconomic fundamentals,’ she says.

Favourable valuations

HBSC head of global emerging market debt Guillermo Ossés also sees value opportunities. ‘Many emerging market corporates currently offer favourable valuations versus their global peers.

‘On average, for similar credit quality, emerging market corporates offer higher yields and more attractive spread levels over their US peers while having lower leverage and sounder balance sheets,’ he says.

‘For example, year to date 2012 (to mid-October) BBB-rated emerging market corporates have an average spread level of 331 basis points compared with 237bps for US BBB-rated corporates, with almost half the average net leverage, 1.06 versus 1.92 respectively.’

While Ossés accepts the challenges driven by market dynamics and investor perception remain, along with potential liquidity problems in a market downturn, he believes corporate debt will reward investors over the longer term.

‘We expect these issues to improve over time as the asset class develops, and we believe the positive benefits of investing in EMD corporates far outweigh these challenges.’

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