EM Corporate Bonds: A compelling risk-return trade-off
For investors who generally regard emerging market (EM) assets as risky and volatile, it often comes as a surprise that EM corporate bonds have delivered equity-like returns, with a fraction of the volatility. They also have less credit risk and interest-rate exposure than many bond sectors.
By the end of September 2019, default rates for EM high-yield corporates were running at less than 1% a year—comparable to those in developed markets. The J.P. Morgan CEMBI Broad Diversified index had a yield to maturity of 5.1%, with an overall investment-grade rating of BBB-. Investors were earning the bulk of their yield from exposure to the triple B and double B credit categories, accounting for roughly 60% of the index. In most other asset classes, that level of income stream would entail more exposure to frontier or triple-C bonds, neither of which is a big part of the EM corporate index (CCCs are less than 4%).
Return vs. Volatility
Over the past decade, EM corporates have delivered nearly 3% a year more than EM equities, with just over a quarter of the volatility (Display 1) and they have delivered a better risk-return trade-off than most fixed income. EM corporates have returned roughly 2% a year more than euro high yield, at a significantly lower level of annualized volatility, and have been less volatile than US high yield.
We believe this pattern of volatility is likely to continue, because the average credit quality of the asset class has increased over time. New issuance has become increasingly dominated by the higher-quality parts of EM, notably Asia investment grade and Asia double B credit.
We believe EM corporate debt is a reasonable allocation in a variety of interest-rate environments. In a rising interest-rate environment, it has lower duration than many other credit categories (Display 2), with attractive yield.
In a falling interest-rate environment, particularly when fears of recession are looming, EM corporate debt’s relatively high credit quality should help it to outperform other higher-yielding asset classes, as it has in periods of volatility in the past decade.
Emerging markets corporate debt, like any other risk asset, goes through patches of volatility. But in the past decade it has offered investors better compensation for risk than any other EM asset class, and market inefficiencies and information gaps have offered frequent opportunities for active managers to outperform the index. For investors looking for higher yield or emerging markets exposure, we believe that EM corporates have a valuable part to play in long-term portfolio allocation.
Display 1: Attractive Long-Term Return vs. Volatility
Display 2: Attractive Yield vs. Interest-Rate Risk
Past performance is not a reliable indicator of future performance.
As of 30 September 2019. Returns are in US dollars. Volatility refers to annualized standard deviation. EM Sovereign Hard Currency—J.P. Morgan EMBI Global; EM Sovereign Local Currency—J.P. Morgan GBI – EM Global Diversified; EM Corporate—J.P. Morgan CEMBI Broad Diversified; Euro High Yield—Bloomberg Barclays European High Yield; US High Yield—Bloomberg Barclays U.S. High Yield; US Investment Grade—Bloomberg Barclays U.S. Corporate Investment Grade; Euro Investment Grade—Bloomberg Barclays European Corporate Investment Grade; U.S. Treasuries—Bloomberg Barclays U.S. Aggregate—U.S. Treasury; International Bonds—Bloomberg Barclays Global Aggregate ex U.S.; Bunds—Bloomberg Barclays Global Aggregate – German Bund; JGB—Bloomberg Barclays Global Aggregate – Japanese Government Bond; EM Equity—MSCI EM Index. Source: Bloomberg Barclays, J.P. Morgan, MSCI. See Additional Information.
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