Focus on emerging markets – Healthy EM credit yields to soften

Corporate bonds from companies in emerging markets will still return more than their developed market equivalents, but a more diversified market threatens to force yields down over time, according to Investec Asset Management.

Victoria Harling, a portfolio manager and corporate bond specialist at Investec, says a compression in spreads of up to 0.7% from current levels is possible.

She said the category of EM corporate bonds has grown seven fold in volume since 2002, making it the fastest growing asset class within emerging market debt over that period.

She adds the volume of assets invested in the category increased by 70% last year, and then already increased by another 20% so far this year.

However, a continuation of the growth in volume will lead to lower yields. Harling adds these will come from companies with relatively conservative balance sheets, higher interest coverage and lower leverage.

Yet allocators remain underinvested in the category compared to their holdings in EM hard currency – US dollar denominated – sovereign debt.

Around 7% of the total money invested in emerging markets funds is in corporate bonds, far less than the 50% of EM allocations invested in sovereign bonds.

Harling expects there will be more corporate bonds issued by EM companies as the countries they are based in develop themselves – economically, socially and politically.

Since the onset of the first global financial crisis in 2008, more and more emerging market companies have started issuing bonds, says Harling, broadening from a market predominantly of blue chip names, largely financed by banks.

“Since the crisis, debt is becoming increasingly publicly funded,” she said.
The JPMorgan Emerging Markets Global Diversified Index still largely consists of better-known large names, such as Petrobras and Gazprom.

Smaller companies are initially often unable to issue bonds large enough to satisfy the conditions of inclusion in the index, which has a threshold of $300m.

But as the EM market matures and companies grow, more and more companies are able to increase the size of their issuances.

Once companies are included in a widely followed corporate bond index, their bonds become more investable, and investors following the benchmark must buy them if they are in the index.

One example is Georgian Railway JSC, which in June issued a $500m bond, the first time it had done so. It thus qualified for inclusion in the index.

Harling said Georgian corporate debt is looking particularly attractive, especially as the country develops its oil and gas sector.

She believes specialised EM asset managers are best placed to take advantage of such smaller names, as managers focused on those markets have dedicated teams behind the selection process.

Harling expects the asset class to attract more and more assets as investor confidence grows.

In the current risky environment and with corporate growth rates slowing, she sees EM corporate bonds as a safer alternative to EM equities.

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