25 January 2012 Is there opportunity in EM corporate debt?

Peter Eerdmans, Head of the Emerging Markets Debt Team at Investec Asset Management, explores developments for 2012 and explains why the fastest growing area of the asset class – EM corporate debt – may continue to provide an investment opportunity

While the fundamental story for EMs remains largely intact, we expect market volatility to continue for the time being, moving in line with developments in Europe and the US, but to ultimately post a positive year. We also believe that 2012 should be another strong year for issuance from both EM sovereigns and corporates, given that concerns about Europe and deteriorating global economic growth prevented many from tapping the bond market in 2011.

The EM corporate debt market is the fastest growing area of EM debt with investors increasingly recognising its potential given that yields are attractive relative to fundamentals. We believe that rising flows into EM credit are part of a wider EM debt story, with investors also looking to increase allocations to sovereign debt, both in local currency and hard currency. We believe that under a reasonable growth scenario for 2012, EM corporate debt can show attractive returns. The reasons supporting this view include the following:

• EM investors have not had the opportunity to ease into 2012 – since the new year began, both EM sovereigns and corporates have issued a significant amount of new bonds, enticing investors to spend. Six EM sovereigns have come to market and demand has been strong: Mexico issued a new $2 billion, 10-year bond at a record low yield of 3.6%, receiving three times the orders it required. South Africa received double the necessary orders for its $1.5 billion 12-year issue. In the corporate world, nine new bonds have been issued, raising $9.25 billion (compared with $35 billion in January last year). These have been equally popular – Vale’s new $1 billion, 10-year bond was three times oversubscribed, and the 30-year issue from Korea Gas was nine times oversubscribed. According to JP Morgan estimates, EM sovereigns are expected to raise $60.4 billion this year (excluding issuance in their local currencies) and corporates are looking to raise $185 billion.

• In part, investor appetite for EM issuance has stemmed from a desire to diversify away from the volatile and troubled European bond market. Since 2008, EMs have received 136 ratings upgrades, with a further 23 expected this year. While aggregate EM growth will slow – to a forecasted 5% in 2012 – it remains better than the no-growth scenario predicted for Europe and the 1.6% forecast for the US*.

• Looking more closely at EM corporate debt, flows from crossover investors – those able to invest across developed and emerging bond markets – have supported the growth of EM credit so far with assets in dedicated EM credit funds growing by 75% in 2011. US dollar bond inflows to EM credit have been fairly steady despite the market volatility of 2011 and we would expect these flows to remain positive – a 6.3% aggregate yield for an EM corporate bond index looks attractive relative to US investment grade (3.9%). Separately, ratings agencies continue to penalise EM corporates over US corporates with the same financial strength. Default rates should remain below 3% (excluding two well-flagged defaults, BTAs and Sino-Forest). At this rate, a maximum of nine companies would default, out of a total 350 issuers. In fact, defaults may be well below that number if governments decide to use fiscal policy to stimulate growth or central banks cut interest rates later this year. Longer term, the structural EM growth story of rising consumer spending, an expanding industrial base and increased foreign investment remains intact.  The under-penetration of EM credit is highlighted by the fact that dedicated EM corporate funds still comprise just 5% of the EM corporate benchmark, while dedicated EM sovereign external debt funds comprise 50% of the external sovereign benchmark.

*Source: BNP Paribas

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ENDS

Notes to Editors

Investec Asset Management is an independently managed subsidiary of Investec Group. Investec Asset Management is a specialist investment manager, providing a premier range of products to institutional and individual investors. Established in 1991, the firm has been built from start-up into an international business managing approximately US $83bn* on behalf of third party clients. We have grown from domestic roots in Southern Africa and the UK to a position where we proudly serve a growing international client base from the Americas, Europe, Asia, Australia, the Middle East and Africa. We employ over 125 investment professionals. The firm seeks to create a profitable partnership between clients, shareholders and employees, and to exceed expectations for both client service and performance.

*As at end Sept 2011

 

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