The fastest growing segment of fixed income
Emerging market debt has gained significant prominence over the last two decades, in both economic and financial spheres. The share of emerging market bonds within the global bond market was around 10% in 2004, whereas now it accounts for almost one third of the global bond market.1 We submit that it is an asset class that cannot be ignored anymore.
Within emerging market debt, emerging market hard currency corporate debt has gained even more traction. Far from a mature asset class but no longer the new kid on the block, it currently stands at 2.5 trillion USD2, and deserves attention when compared to peers such as US corporates and on its own right. It is the fastest growing fixed income segment over the past 20 years, and spans more than 60 emerging market countries and 700 issuers.3 It offers a multitude of potential benefits across the fixed income space including diversification for resilient income opportunities and the ability to express sectoral themes to complement sovereign macro views. Furthermore, different sovereigns often have varying structural and cyclical drivers, offering further diversification. Finally, we see abundant alpha opportunities from bottom-up credit stories.
Figure 1: Asset Class Growth
Emerging Market Corporate is one of the fastest growing segments in fixed income.
Source: JP Morgan, June 2024.
Attractive risk return profile
We believe emerging market hard currency corporate debt is an asset class well suited for long term investors that seek structural risk premium and compelling risk adjusted returns.
If we divide emerging market (EM) corporate debt further into high yield (HY) and investment grade (IG) segments and compare it with developed market peers, we see that both EM HY and EM IG offer compelling yield pick-ups over their respective developed market (DM) peers, while the credit ratings are the same or similar between EM IG and DM IG and the credit ratings for EM HY are overall higher than DM HY.4 If the combination of better credit ratings and higher yields sounds too good to be true, the yield pick-ups become even more compelling after adjusting for duration, as emerging market corporates typically have a shorter duration profile than their global and US peers. Regressions throughout time show that while the exact amount of yield pick-up changes, the fact that emerging market corporates offer stronger credit and duration risk adjusted rewards persists, evidencing structural risk premium that can be harvested by long term investors.5
Figure 2: Yield vs. Credit Rating
Dark Blue squares = Developed Markets.
Source: JP Morgan, Bloomberg, August 2024 It is not possible to invest directly in an index. Please see index descriptions at the end of this document. Past performance is not indicative of future results.
The “Zip Code” effect
The next logical question is why such structural risk premium exists in emerging market corporate debt. We believe the “zip code effect” plays a large role here. It is much like the case of a house of high quality and specification but located in a not so desirable neighborhood, that may incur a discount to its fair value. In emerging market corporates, we see similarly rated companies often have better credit fundamentals and higher yields than developed market peers. This is a result of the “sovereign rating cap” framework, which means that emerging market corporates, even the ones with the strongest fundamentals, cannot be rated above their respective sovereign rating unless these corporates are considered global, evidenced by deep revenue diversification and a large share of hard currency earnings.
The zip code effect can lead to various investment opportunities. From the top-down perspective, this means the asset class is often perceived as riskier than we believe it actually is, leading to favorable strategic asset allocation considerations. From the bottom-up perspective, the co-independence between sovereigns and corporates can offer attractive alpha opportunities. The opportunities are particularly abundant in countries where the sovereign fundamentals are improving with structural reforms and/or more orthodox macroeconomic policies. As these countries achieve sovereign rating upgrades, many corporates domiciled in these countries will also experience credit rating upgrades, in some cases from high yield to investment grade. Turkey is a good current example, where the country is undergoing positive macro adjustments and being awarded with gradual credit rating upgrades.
Solid standalone corporate fundamentals
Away from the sovereign zip code effect, the solid and improving fundamentals of emerging market corporates cannot be overlooked. The strong fundamentals are evidenced by lower net leverage ratios at every rating bucket vs. developed market peers, strong access to refinancing via local markets and banks and prudent liability management leading to smooth debt maturity profiles.6
Figure 3: Net Leverage Ratios for EM and DM Corporates
Source: JP Morgan, June 2024. It is not possible to invest directly in an index. Please see index descriptions at the end of this page.
Higher quality investment universe composition
Going forward, we anticipate the overall credit quality of emerging market corporates will continue to improve. We believe the elevated defaults in the last couple of years caused by the Chinese real estate and Russian-Ukraine conflict are largely behind us as these defaulted bonds exit the universe. New issuances have been heavily skewed towards higher rated bonds and higher quality segments, supporting the composition of the investment universe tracked by widely used indices such as JP Morgan CEMBI Broad Diversified index.
Capturing favorable sectoral trends
Coming back to solid corporate fundamentals, there are certain sectors we particularly like as a result of their operating and financing models. One example is infrastructure. In emerging market countries we still see the need for large infrastructure spending, ranging from growing renewable generation and grid expansion to building the necessary infrastructure to support growth in commodity trades. We see unique opportunities to gain exposure to project finance type structures that offer strong creditor protection features while benefiting from stable cash flow generation and strong asset quality.
Favorable technical tailwind
One interesting trend we have seen for the past couple of years is strong interest in emerging market hard currency corporates from global and crossover investors, combined with negative debt issuance from the asset class. As a result, we are seeing heavier demands for the asset class but more limited supply from issuers, i.e. more investors seeking fewer bonds. This partially explains the yield pick-ups of EM over DM corporates, and while they remain positive and we feel are worth seeking, yield pick-ups are at the tighter end of their historical range. We think strong demand from this wider investor base will persist as a result of overall compelling yield levels, improving quality of the asset class and providing significant diversification benefits. For institutional insurance investors, the investment grade segment may be particularly attractive as a core allocation, whereas the high yield segment can offer more dynamic opportunities to capture both positive bottom up credit stories and sovereign structural reform trends.
At MacKay Shields, our deep experience in delivering sharp, integrated emerging market sovereign and corporate research, combined with our strong expertise in global fixed income and credit, enables us to identify both standalone emerging market and crossover global opportunities and deliver tailor made solutions to institutional investors.
1. JP Morgan, August 2024
2. JP Morgan, August 2024
3. JP Morgan, August 2024
4. JP Morgan; ICE Data, Bloomberg, August 2024
5. JP Morgan; ICE Data, Bloomberg, August 2024. Based on an analysis of emerging market and developed market indices as of 30th August 2024. See Figure 2. Does not represent any product or strategy managed by MacKay Shields LLC or its affiliates and should not be construed as such. Past performance is not indicative of future results.
6. Source: JP Morgan, June 2024
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Past performance is not indicative of future results.
COMPARISONS TO AN INDEX
Comparisons to a financial index are provided for illustrative purposes only. Comparisons to an index are subject to limitations because portfolio holdings, volatility and other portfolio characteristics may differ materially from the index. Unlike an index, individual portfolios are actively managed and may also include derivatives. There is no guarantee that any of the securities in an index are contained in any managed portfolio. The performance of an index may assume reinvestment of dividends and income, or follow other index-specific methodologies and criteria, but does not reflect the impact of fees, applicable taxes or trading costs which, unlike an index, may reduce the returns of a managed portfolio. Investors cannot invest in an index. Because of these differences, the performance of an index should not be relied upon as an accurate measure of comparison.
SOURCE INFORMATION
“Bloomberg®”, “Bloomberg Indices®”, Bloomberg Fixed Income Indices, Bloomberg Equity Indices and all other Bloomberg indices referenced herein are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the indices (collectively, “Bloomberg”) and have been licensed for use for certain purposes by MacKay Shields LLC (“MacKay Shields”). Bloomberg is not affiliated with MacKay Shields, and Bloomberg does not approve, endorse, review, or recommend MacKay Shields or any products, funds or services described herein. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to MacKay Shields or any products, funds or services described herein.
All ICE Data Indices referenced herein (Each such Index, The “INDEX”), are products of ICE Data Indices, LLC (“ICE DATA”), and are used with permission. ICE® is a registered trademark of ICE Data or its affiliates, and BofA® is a registered trademark of Bank of America Corporation licensed by Bank of America Corporation and its affiliates ("BofA") and may not be used without BofA's prior written approval. ICE DATA, its affiliates and their respective third part suppliers disclaim any and all warranties and representations, express and/or implied, including any warranties of merchantability or fitness for a particular purpose or use, including the Indices, Index data and any data included in, related to, or derived therefrom. Neither ICE Data, its affiliates nor their respective third party suppliers shall be subjected to any damages or liability with respect to the adequacy, accuracy, timeliness or completeness of the Indices or the Index data or any component thereof, and the Indices and Index data and all components thereof are provided on an “AS IS” basis and your use is at your own risk. Inclusion of a security within an Index is not a recommendation by ICE Data to buy, sell, or hold such security, nor is it considered to be investment advice. ICE Data, its affiliates and their respective third party suppliers do not sponsor, endorse, or recommend MacKay Shields LLC, or any of its products or services.
INDEX DESCRIPTIONS
JPMORGAN CEMBI GLOBAL DIVERSIFIED INDEX ─ JPMorgan CEMBI Global Diversified Index is an unmanaged, market-capitalization weighted, total-return index tracking the traded market for US-dollar-denominated Brady bonds, Eurobonds, traded loans, and local market debt instruments issued by sovereign and quasi-sovereign entities.
ICE BofA Liquid U.S. Treasury Index – tracks the performance of USD denominated sovereign debt publicly issued by the US government in its domestic market. Bills, inflation-linked debt and strips are excluded from the Index.
JPMORGAN CEMBI BROAD DIVERSIFIED HIGH YIELD INDEX – JPMorgan CEMBI Broad Diversified High Yield is a sub components of the JPMorgan CEMBI Div Broad Composite Blended Yield Index, which cover the sub investment grade part of this composite index.
JPMORGAN EMBI GLOBAL DIVERSIFIED INDEX ─ JPMorgan EMBI Global Diversified Index is an unmanaged, market-capitalization weighted, total-return index tracking the traded market for US-dollar-denominated Brady bonds, Eurobonds, traded loans, and local market debt instruments issued by sovereign and quasi-sovereign entities.
JPMORGAN GOVERNMENT BOND–EMERGING MARKET INDEX – JPMorgan GBI-EM Global Diversified (GBI-EM) series, launched in June 2005, is the first comprehensive global emerging markets index of EM local government bond debt. There are three root versions of the GBI-EM with a Diversified overlay for each version; GBI-EM Broad / GBI-EM Broad Diversified, the GBI-EM Global / GBI-EM Global and the GBI-EM / GBI-EM Diversified.
JPMORGAN CEMBI BROAD DIVERSIFIED HIGH GRADE INDEX - JPMorgan CEMBI Broad Diversified High Grade is a sub components of the JPMorgan CEMBI Div Broad Composite Blended Yield Index, which cover the investment grade part of this composite index
ICE BANK OF AMERICA US HIGH YIELD INDEX - ICE BofA US High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market. The ICE BofA US High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market.
ICE BANK OF AMERICA US CORPORATE INDEX - The ICE BofA US Corporate Index tracks the performance of US dollar denominated investment grade corporate debt publicly issued in the US domestic market.
ICE BANK OF AMERICA GLOBAL HIGH YIELD INDEX - ICE BofA Global High Yield Index tracks the performance of USD, CAD, GBP and EUR denominated below investment grade corporate debt publicly issued in the major domestic or eurobond markets.
ICE BANK OF AMERICA GLOBAL CORPORATE INDEX - ICE BofA Global Corporate Index tracks the performance of investment grade corporate debt publicly issued in the major domestic and eurobond markets. Qualifying securities must have an investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity as of the rebalancing date and a fixed coupon schedule.
ICE BANK OF AMERICA EURO CORPORATE INDEX - ICE BofA Euro Corporate Index tracks the performance of EUR denominated investment grade corporate debt publicly issued in the eurobond or Euro member domestic markets. Qualifying securities must have an investment grade rating (based on an average of Moody’s, S&P and Fitch) and at least 18 months to final maturity at the time of issuance. In addition, qualifying securities must have at least one year remaining term to final maturity, a fixed coupon schedule and a minimum amount outstanding of EUR 250 million.
ICE BANK OF AMERICA EURO HIGH YIELD INDEX - ICE BofA Euro High Yield Index tracks the performance of EUR denominated below investment grade corporate debt publicly issued in the euro domestic or eurobond markets.
USE OF ISSUER NAMES
Issuer names used herein are provided as examples for educational and illustrative purposes only and are not intended, nor should they be construed as, recommendations to buy or sell any individual security.
NOTE TO UK AND EUROPEAN AUDIENCE
This document is intended only for the use of professional investors as defined in the Alternative Investment Fund Manager’s Directive and/or the UK Financial Conduct Authority’s Conduct of Business Sourcebook. To the extent this document has been issued in the United Kingdom, it has been issued by MacKay Shields UK LLP, 80 Coleman Street, London, UK EC2R 5BJ, which is authorised and regulated by the UK Financial Conduct Authority. To the extent this document has been issued in the EEA, it has been issued by NYL Investments Europe Limited, Hamilton House, 28 Fitzwilliam Place, Dublin 2 Ireland, which is authorised and regulated by the Central Bank of Ireland.
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