March 2021 / VIDEO
Attractive Risk-Return Tradeoff in EM Corporates
A history of equity-like returns, with a fraction of the volatility
EM debt represents a large and diverse opportunity set. With over US$6 trillion of bonds outstanding it rivals both US investment-grade corporates and EM equity in scale. Furthermore, emerging corporate debt is over US$2 trillion in size. It's larger than both the sovereign market for EM and also larger than US high yield. However, investor allocations to emerging corporates are a fraction of those two categories. This is something that we feel will change in the years ahead. We feel advocacy for the EM credit category as an asset class will increase as clients better understand the quality of the income stream that underlies EM corporate debt.
EM corporate debt has high yields, but with an average investment-grade credit quality. Importantly, investors are obtaining that yield through harvesting risk and illiquidity premia in the triple B and double B credit categories primarily, whereas in other asset classes to obtain that same income stream you would need to take on either frontier market risk or triple-C bonds, both of which are fairly de-emphasised in the EM corporate category.
We feel the relative quality of Emerging corporate debt has also been empirically evidenced through history and a 10-year risk-return profile: high returns with moderate level of volatility. We do feel that this is something this likely to continue, because the average credit quality of the asset class has actually increased over time, because the vast majority of supply in recent years has come from the highest quality parts of EM, in particular Asia investment grade and Asia double B credit Emerging corporate debt is a reasonable allocation in a variety of interest-rate environments.
In a rising interest rate environment, it has lower duration than most other credit categories. In a falling interest rate environment, in particular where fears of recession are looming, keep in mind this is an average investment-grade quality asset class, so will likely outperform other higher-yielding asset classes as it has in prior periods of volatility in the last decade.
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