Warren Hyland: «Meeting the Need for Yield»

By Warren Hyland, Portfolio Manager at Muzinich & Co.

Over the last 20 years, emerging market corporate bonds have become an established asset class, with the hard currency segment now totaling around 1.5 trillion dollar.¹

The investible universe offers significant opportunities via exposure to over 50 countries at different stages of the economic cycle, as well as multiple industries.² EM corporate bonds can offer much greater diversification across sectors via exposure to industries such as paper, healthcare, protein, utilities, and telecoms, etc. Credit quality is comparable to developed market bonds and the universe has an average investment-grade rating.³

An investment can offer investors access to the long-term secular growth story of emerging markets, which are playing catch up with their developed market counterparts. Most EM countries are in rate-cutting mode which, alongside fiscal expansion, could provide support for further growth in the medium and long term.

Solid Fundamentals

We believe the medium-term outlook for the asset class also looks solid. Fundamentals are improving with leverage declining, in contrast to rising leverage in some areas of developed market corporate bonds.⁴

In addition, EM corporate spreads are higher than similarly rated bonds in developed markets; in effect, investors are being paid to take less risk.⁵

While investors can access the asset class via hard or local currency instruments, it’s worth noting that the local currency segment tends to be more volatile because of the foreign exchange component of local currency bonds.

In addition (and unlike emerging market sovereign bonds) only the highest-quality corporates issue in hard currency as they can overcome the high barriers to entry to be eligible to list internationally. These companies are often located in the strongest sovereigns which no longer need to issue hard currency debt, giving investors exposure to countries they would otherwise be unable to access.

A Range of Risk Profiles

For investors interested in an allocation to emerging market debt, but want to reduce their overall risk profile, we believe an allocation to the shorter duration segment could offer an appropriate solution. As well as having less sensitivity to interest rate risk, shorter duration bonds tend to be less volatile, thus offering downside protection alongside coupon income. As an alternative, the regular duration option can offer the potential for growth alongside the coupon income.

For fixed-income investors faced with trillions of dollars of negative-yielding debt, we believe emerging market corporate bonds may offer a higher-yielding solution to similarly rated bonds in developed markets.

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Warren Hyland has been a portfolio manager for emerging markets at Muzinich & Co. since 2013. He has 20 years of corporate credit experience. Warren has a BSc in Mathematics for Business from the Middlesex University London and later received his MSc in Shipping Trade and Finance from the CASS Business School. He holds the Chartered Financial Analyst designation.

¹ BAML Markets EM Corporate Monthly, a total of EM IG and EM HY Broad Corporates outstanding, as of 4th October September 2019.
² Country split of ICE BAML Emerging Markets Corporate Plus Index, as of 31st October 2019
³ Average rating of ICE BofA Merrill Lynch Emerging Market Corporate Liquid Index is BBB3, as of 31st October 2019
⁴ Bank of America Merrill Lynch, Monthly Emerging Market Corporate Chartbook, based on net leverage falling from 2.4 as if 30th June 2016 to 1.5 as of 31st December 2018. Net Leverage ex-utilities in US BBB risen from 1.3 as of Q1 2004 to 3 as of Q2 2019, source JPMorgan, as of 30th June 2019.
⁵ Based on STW of ICE BofA ML BBB US Corporate Index, ICE BofA ML BBB Euro Corporate Index and ICE BofA ML BBB US Emerging Markets Liquid Corporate Plus Index as of 18 October 2019.

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