Background
The shift to a new macroeconomic regime is among factors that have redrawn the fixed income investment landscape in the past few years. Major economies like the US are only just getting to grips with inflation – with rates set to remain higher for longer than many had hoped. They also face the daunting prospect of returning fiscal deficits to a post-pandemic sustainable path. Add to that a proliferation of election-related uncertainty and increasing divergence across global economies, and old labels used by asset allocators no longer seem useful or fitting. This is particularly the case for ‘emerging markets’ – a label synonymous with higher volatility, lower perceived credit quality, and greater political uncertainty.
Emerging markets in a new era
Last year, my colleague, Peter Kent, discussed the ‘blurring of lines’ between developed and emerging market (EM) debt that has taken place in recent years. Outlining developments – such as proactive rate cutting – that have underpinned a strengthening of EM fundamentals, Peter illustrated how this was feeding through into resilient sovereign debt market performance. He also drew contrasts with the shift that has taken place in the developed market universe to result in a much more volatile fixed income market regime there.
Since then, elections in emerging markets including India, South Africa and Mexico have evidenced peaceful democracy in action, with predominantly market-friendly outcomes. The greatest uncertainty facing investors stems from the looming US election.
Turning to the macroeconomy, while inflation finally seems to be trending down in the US, many EM central banks are further ahead in their rate-cutting cycles. This, together with fundamentals that are generally on a positive trajectory (see Appendix), puts EM economies at an advantage.
Monetary policy rates across the US, EU and EM (%)
Source: Bloomberg, Ninety One, April 2024. EM is the weighted average of emerging market countries in the JPMorgan GBI-EM GD benchmark.
An updated view on EM corporate credit issuers
Strong foundations and growing tailwinds
The fundamental improvements seen in EM economies naturally provide firmer foundations for the companies operating in them – and for the debt they issue. But that’s only part of the story. The world order is undergoing a significant shift. The unipolar dominance of the past, characterised by the United States as the sole superpower, is transitioning to a multipolar world marked by various centres of economic, political, and military influence. Power shifts, by their nature, create both volatility and opportunity.
Countries that diversify their economies, build strong regional alliances, and can navigate between different global powers are likely to benefit. Winners will also include those countries and markets that are geographically well-positioned to benefit from trends like nearshoring1 or friendshoring2. For example, Mexico has benefitted as US companies build manufacturing operations nearer to home. Similarly, India has benefitted as companies like Apple, following the COVID-triggered supply-chain crisis, has implemented a plan to ship 40% to 45% of iPhones from India, compared to a single-digit percentage in 20223. These nearshoring and friendshoring strategies, aligned with companies’ and countries’ de-risking strategies, will reconfigure supply chains, as well as trade and investment flows, especially for strategic goods and services.
Market-leading global companies
It is an often-overlooked fact that emerging markets are home to many market-leading companies, with a global footprint and geographically diverse revenue sources.
Leading global brands that are owned or controlled by emerging market corporates
Prudent financial management
It’s also a well-kept secret that EM companies typically have very low leverage. These companies are familiar with volatility and have historically experienced periods when they struggled to finance themselves with longer-term debt. Thus, their short-term debt is higher as a percentage than it is in DM companies, and their refinancing risks have historically been higher. This has led to a culture of retaining cash while containing leverage. This has been particularly evident since the COVID crisis, as many companies have pared back their expansion and capital expenditure, leaving them with healthy cash balances and strong buffers.
In contrast, leverage rates among companies based in the US and other developed markets have risen, and with the era of exceptionally loose monetary policy now behind us, companies face a very different (more challenging) reality in the new macro regime. Furthermore, in developed markets, the higher-for-longer rates backdrop is likely to be further exacerbated by persistent fiscal imbalances. All at a time when potentially profound political changes are on the horizon.
Leverage levels
Source: JPMorgan, September 2023.
A look behind the labels
Given the dynamics discussed above, we think the case for including EM credit alongside DM allocations in portfolios is strong. But pre-existing perceptions can be hard to shift. To help inform an up-to-date view, we share some key metrics below of the large, diverse and maturing asset class of EM credit.
Yields
Source: JP Morgan, BofA, 30 June 2024. EM data is from JP Morgan CEMBI IG/HY indices, while US IG/HY data is from BofA indices.
Not only is the EM asset class a globally diverse universe that spans continents, in many ways, EM and DM/US credit markets are alike. In some respects, EM credits have more favourable characteristics. A look at the key characteristics of the asset class today and how it stacks up suggests it can play a useful role in a broader credit/ growth fixed income allocation.
Comparison of two major tech sector companies – one based in an emerging market, the other in the US.
 Mercado Libre |
 eBay |
|
|---|---|---|
| Industry | Online marketplace | E-commerce |
| Country | Argentina | US |
| Market position | Leading e-commerce player in home market | Leading e-commerce player in home market |
| FY23 Total footprint | GMV*: $45 bn | GMV: $73 bn |
| Market capitalisation (USD) | $87.8 bn | $27.9 bn |
| FY23 Revenues (USD) | $14.4 bn | $10.1 bn |
| FY23 Net Leverage | Negative (-0.3x) | 1.3x |
| Rating (M/S/F) | Ba1/BB+/BB+ | Baa1/BBB+/NR |
| Credit spread to US Treasury | 240 bps | 115 bps |
| 10yr bond yield** | 6.2% | 5.0% |
This is not a buy, sell or hold recommendation for any particular security. Securities chosen are for illustrative purposes only.
Source: Bloomberg, Ninety One. Market cap, rating, credit spread and bond yield as at 5 August 2024.
*GMV is gross merchandise value.
**The Mercado Libre bond used matures in 2031; The eBay bond used matures in 2032. Yield is yield-to-worst.
Conclusion
Asset allocators have typically overlooked the EM corporate bond market, with negative perceptions behind the EM label partly to blame. Yet various developments over recent years put those views to the test. The EM credit opportunity set today compares very favourably across a variety of metrics; in many cases, macro and micro fundamentals in EM are superior to developed markets, such as the US. Asset allocators who take a fresh perspective on EM can find a compelling investment case. EM credit deserves a place in portfolios.
General risks. 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. Environmental, social or governance related risk events or factors, if they occur, could cause a negative impact on the value of investments.
Specific risks. 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. 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.
Appendix
Macro fundamentals at a glance
In emerging markets, the early part of the 21st century was characterised by reforms and economic strength. Subsequently, vulnerabilities arose in the five years after the Global Financial Crisis, with large current account deficits (financed by loose global liquidity) and weaker fiscal balances exposed during the painful taper tantrum, when EM assets sold off heavily. Crucially, though, this precipitated a significant rebalancing of EM economies, laying a foundation of resilience that served emerging markets well during the COVID pandemic-related shock.
Fiscal policymaking in emerging markets remained prudent during the pandemic, resulting in primary fiscal balances being in surplus across many economies and debt-to-GDP stabilising at modest levels - as shown in the charts below. In contrast, the major stimulus measures unleashed by policymakers in the US and other developed market economies in response to the COVID crisis created sizeable deficits and a heavy debt burden, with no signs of either issue being tackled anytime soon.
EM and US primary balance (% of GDP)
EMBI weighted scores across 79 EM countries
Source: IMF, Ninety One, April 2024. 2013-2023 is used to show the last 10 year average.
EM Debt to GDP
EMBI weighted scores across 79 EM countries
Source: IMF, Ninety One, April 2024.
1 Nearshoring: process of a company relocating business operations to a nearby country, often with a shared border.
2 Friendshoring: the rerouting of supply chains to countries perceived as politically and economically safe or low-risk, to avoid disruption to the flow of business.
3 Wall Street Journal, November 2022.
