Attractive yields in crisis-proven emerging market corporates

Crises are nothing new for emerging markets. In fact, the very concept of emerging markets is so heterogenous and encompasses so many more countries than any other investment universe, it should not come as a surprise that upheavals occur in individual countries, such as Argentina, every three or four years. Nor is it anything new, since emerging markets became accepted as an asset class, that market swoons attract heavy media coverage and spook investors more than similar events occurring in developed markets. That is why the huge drop in investor risk appetite in the first half of 2022 triggered outflows from emerging bond markets. This, along with the well-known geopolitical context, led to steep price declines.

From a valuation point of view, emerging corporate bond markets are now looking compellingly valued. Of course, market volatility remains too high, and this is still keeping investors away. Once volatility recedes, and as investors become less hesitant and more accustomed to sustainably higher inflation than in past decades, we expect risk appetite to recover and inflows to return to the asset class. Moreover, fundamentals are still more attractive in emerging markets, compared to their developed counterparts. Many emerging countries have reduced their public debt, and corporate balance sheets look robust to us in the majority of cases. This is also reflected in moderate default rates – just 0.5% when excluding the ‘special situations’, namely Ukraine/Russia and the Chinese real-estate sector. Furthermore, the latest monetary tightening cycles are quite advanced in some countries, such as Brazil, and are now fully priced in.

As of mid-year, the risk-reward ratio for emerging market corporate bonds has improved considerably. Some equity markets, such as China, have already rallied and partly erased their losses, and we now expect the same to occur in bond markets. Combined with healthy coupons – in the high-yield segment, running yields are in the 8-10% range – emerging market bonds therefore offer commensurate potential for returns. In the current environment, it is hard to have deep conviction in forecasts, and it is still too early to sound the all-clear. But from a sanguine perspective, tough Covid measures are gradually being lifted in China, with a resulting resurgence of economic activity. The Chinese population has high savings, and tourism should benefit, especially as a gateway into other Asian countries. Generally speaking, China could provide a positive impact on global developments if we see a normalisation in relations towards the West. In any case, these remain challenging times, and investors should not overlook crisis-proven emerging markets; more than ever, diversification and layering of investments are key.