Nov 23, 2020
We see a lot of potential for credit markets to perform over the next 12 months. Prospects will be supported by potential COVID-19 vaccines and a US president-elect likely to employ a less confrontational tone, while introducing a more predictable foreign and trade policy. This is likely to play out very well for global growth.
There was a lot of uncertainty priced in during 2020 regarding default risks and credit issues. As the year draws to a close, our view is that many corporates handled the recent global economic lowdown very well, but there is still room for improvement. We like emerging markets (EM) and also credit, and moving slightly down the credit spectrum from investment grade, we see quite a lot of potential for performance in the high yield space as well.
EM corporate debt is rapidly becoming a more mature asset class, but many investors may be unaware that, at US$2.4tn, it is larger than the US high yield market, and roughly the same size as the European high grade market. Rapid growth is being fuelled by new issuers and more countries coming to the market every year.
The result is an asset class including companies from over 59 countries and a lot more diversified than investors might expect to see. These companies will be more globally diversified from a revenue perspective and frequently a bit more conservatively managed than those in developed markets (DM). Default rates in EM are likely to be lower and there are some very good companies across the spectrum in our view.
Perhaps the most important feature of EM corporate debt is that it is becoming quite distinct from the EM sovereign universe. It lends itself to being a nice diversifier; not as a competitor to EM sovereign, rather as a complementary asset class.
The EM investment grade debt market has also expanded, and there has been a lot of traction from investors realising this asset class could be considered an investment grade allocation in its own right against other traditional investment grade credit markets. A key attraction of EM debt over DM are the higher yields available for the equivalent credit ratings.
For investors looking for a reduced duration component but a higher yield component in a world of very low interest rates, EM corporate debt is we believe a highly attractive asset class; default rates are also relatively low. The overall credit quality of the asset class remains higher than traditional US high yield.
EM corporate debt offers slightly lower risk for higher yield, and looking at the different correlations, it fits nicely in an efficient frontier context. Within a blended portfolio, we feel an allocation of 5-10% would complement existing investments in the fixed income universe.
Default: There is a risk that the issuers of fixed income investments (e.g. bonds) may not be able to meet interest payments nor repay the money they have borrowed. The worse the credit quality of the issuer, the greater the risk of default and therefore investment loss. Emerging market: These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems. Interest rate: The value of fixed income investments (e.g. bonds) tends to decrease when interest rates rise. Liquidity: There may be insufficient buyers or sellers of particular investments giving rise to delays in trading and being able to make settlements, and/or large fluctuations in value. This may lead to larger financial losses than might be anticipated.
All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests. If any currency differs from the investor’s home currency, returns may increase or decrease as a result of currency fluctuations. Past performance is not a reliable indicator of future results.