Why should investors consider the asset class?
There are three reasons investors in Australia should consider an allocation to emerging market corporate debt. The first would be coupon. The second would be, durable alpha proposition, and the last would be defensive downside characteristics. A brief comment on each of those.
With respect to the coupon, you have a five and a half percent income stream today, an asset class that has delivered 6.5% annualised returns, but in a higher quality form. Emerging market corporates does not have a much of an allocation at all to the lower rungs of credit quality, such as frontier markets or CCC credit. So, you're harvesting more premium in the middle of the risk category, BB and BBB ratings, but taking less risk down the capital stack.
Secondly, on durable alpha. The top quartile of emerging corporate debt managers have produced more alpha than other credit categories, and that just speaks to the inefficiencies that are still latent within the market as a newer and less sponsored asset class.
And then just lastly with respect to the downside protection in the last 10 year period, the worst annual draw down in an emerging market corporate credit was just barely over 1% and that goes back to the inverse of a higher quality coupon that I referenced earlier. So in a world where you can obtain a coupon in high yield and emerging sovereign, emerging local or emerging corporate, I would suggest that plans take that allocation in a more defensive way versus taking some of the greater draw down risk that's evident in similarly yielding asset classes.
How has EM bonds performed vs EM equities?
I find a lot of Australian plans own very large allocations to emerging market equity in comparison to debt. That does stick out versus other parts of the world. It is sensible given the resident currency, given the proximity to China. However, let's take a step back and move away from theory and just look at returns. Because the theory is such that stocks outperform bonds over the long term. And while that's true in Australia, while that's true in the United States and Europe, it has not been true in emerging markets for the 30-year history of the asset class.
A dollar invested in emerging market bonds would have produced twice the return of emerging market equities over the last 25 years. Because in the hard currency bond space, you're not taking on the currency risk, and you have a much more defensive draw down profile, or you're preserving your capital better in a down-market. A bad year for equities, you may be down 20% or 30%. A bad year for bonds, you're down just a few percentage points. So, it's very difficult to take a high coupon, compound it, and beat that return. That's just an essential principle of investing that I think is often missed when I analyse the construct of today's allocations in Australia.
How could a portfolio benefit from an allocation?
If an investor were to make an allocation to emerging market corporate today, cyclically, I think this could be an opportunity to de-risk your plan. Either de-risking emerging market equity into emerging market hard currency fixed income. Or potentially de-risking your credit allocations, taking money out of private credit, out of US high yield, which has a very large CCC allocation, and putting that into emerging market corporate credit. All those alternatives that I referenced are actually de-risking your plan, but maintaining a high level of income, which we all know is important in a low yielding world.
Unless otherwise stated, all data is sourced from T. Rowe Price as of 23 August 2019. This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision.
T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.
The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction. Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources' accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price. The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.
Australia - Issued by T. Rowe Price Australia Limited (ABN: 13 620 668 895 and AFSL: 503741), Level 50, Governor Phillip Tower, 1 Farrer Place, Suite 50B, Sydney, NSW 2000, Australia. For Wholesale Clients only.
New Zealand - Issued by T. Rowe Price Australia Limited (ABN: 13 620 668 895 and AFSL: 503741), Level 50, Governor Phillip Tower, 1 Farrer Place, Suite 50B, Sydney, NSW 2000, Australia. No Interests are offered to the public. Accordingly, the Interests may not, directly or indirectly, be offered, sold or delivered in New Zealand, nor may any offering document or advertisement in relation to any offer of the Interests be distributed in New Zealand, other than in circumstances where there is no contravention of the Financial Markets Conduct Act 2013.
© 2019 T. Rowe Price. All rights reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc.