(Bloomberg) -- Investors are turning more selective on emerging-market corporate bonds, betting that only a few will continue to provide strong returns and insulation from monetary policy turmoil in what’s expected to be a volatile second half of the year.
Money managers from Aegon Asset Management to Lazard Asset Management and T. Rowe Price are among those touting high-yield, dollar-denominated bonds from emerging-market firms. Shorter durations and credit quality that often surpasses that of their host nations help make the trade attractive, they say, even as the murkiness around the Federal Reserve’s timing to lower interest rates — not to mention the US presidential election — puts a lid on a widespread rally in risk assets.
“Our focus has been shifting out of lower-rated corporates into either more stable or higher-rated corporates,” said Jeff Grills, head of emerging markets debt at Aegon, who’s overweight on corporate debt. “We’re nervous as we get into the second half of the year, depending on what the Fed does.”
Fed officials are widely expected to hold borrowing costs steady in July. Soft data from the world’s largest economy has the market betting on at least two cuts before the end of 2024, starting in September, according to futures pricing.
It’s been a year of outperformance for emerging-market corporate bonds so far. The Bloomberg EM USD Aggregate Corporate Index gained in seven out of the past eight months, returning 4.8% year-to-date compared to a 3.4% gain by the sovereign gauge. Local currency debt is down less than 0.1% in the span.
“EM corporates are more shielded than sovereigns from tighter financial conditions,” said Samy Muaddi, head of emerging markets fixed income at T. Rowe Price, pointing to the notes’ shorter duration profile compared with sovereigns and “conservatively leveraged” balance sheets. Muaddi likes BBB and BB-rated corporates in Brazil, Mexico, Colombia, Philippines, India, and eastern Europe.
Fewer Defaults
Credit quality has also been improving for companies in developing nations. The yield spread between EM corporate debt and the Bloomberg US Corporate Total Return Index has tumbled 60 basis points this year, hitting the lowest level since April 2018 and signaling increased strength in the asset class. Even with the rally, absolute yields continue to look attractive relative to many other fixed income asset classes, according to Omotunde Lawal, head of EM corporate credit at Barings Investment Services.
Default rates in emerging markets will also decline this year, Moody’s Ratings projects, with the rate for speculative-grade, nonfinancial corporate issuers falling to 3.9% by year-end. That’s lower than a historical average of 5.3%, and pushes close to the estimated advanced economy rate.
“There is some relative pickup in emerging-market high yield corporates,” said Anthony Kettle, senior portfolio manager at RBC Bluebay, who likes double-B names in Mexico and triple-C credits in Argentina. “And with the falling default rate, it leads you to be reasonably constructive on the asset class.”
Bond Picks
Lazard’s Arif Joshi looks for names that have a high probability of getting an upgrade to investment grade. Over the long term, he said, the spread compression for a company going from double B to triple B is “much greater in terms of capital return than any other credit upgrade.”
Utilities and pipelines with long-dated contracts are particularly attractive, offering “exaggerated spread” while being less exposed to macroeconomic uncertainties, he added.
The primary market has also been providing opportunities.
“The new issue market, especially for corporates, have been very much in demand by managers like ourselves,” said Aegon’s Grills. “Especially when you get into double B and single Bs, they still offer very interesting value on the new issue market because those tend to need to come with a premium.”
Grills cited a newly issued $500 million bond by Dominican Republic airport operator, Aeropuertos Dominicanos, as an example. With a 7% coupon, the note that matures in 2034 is trading just above par at 102 cents on the dollar, according to Trace data.
Latin America
Ninety One’s Alan Siow says he’s overweight Latin America, with exposure in Mexico and Brazil. The former should continue benefiting from the so-called nearshoring, while in Brazil he likes companies including Braskem SA and BRF SA.
The region is also a favorite of Rodica Glavan, head of EM corporate fixed income at Insight Investment Management in London, who sees it as “most attractive” in its spread pickup versus fundamentals.
“Look at this period we’re in, with the macroeconomic backdrop of healthy global growth environment and a Fed about to cut not just once, but twice this year,” said Glavan. “This is the right time for money to start pouring in into emerging-market corporate bonds.”
What to Watch
- In Brazil, the mid-July CPI print will likely show inflation remained tame despite currency pressure; meanwhile in Mexico, the inflation rate likely rose in the first two weeks of July, driven by higher non-core food and energy prices
- Both Russia and Nigeria look set to lift interest rates, while Turkey’s central bank will likely keep rates steady
- India will release its budget for fiscal 2025
- The Central Bank of Sri Lanka is likely to cut rates and South Korea is set to publish GDP data that show growth slowed sharply in the second quarter
--With assistance from Jorgelina do Rosario and Maria Elena Vizcaino.
©2024 Bloomberg L.P.
