November 30, 2020
Insight’s head of emerging market debt and emerging market corporate debt agree, bonds in their universe look attractive for 2021 and likely set for a good year but it won’t be all smooth sailing.
The emerging market corporate bond (EMCD) market looks to start the New Year in better shape than many asset classes, according to Insight Investment. Colm McDonagh, head of emerging market debt (EMD) at the group, anticipates attractive returns for EMCD in 2021; some 4.5% of which he believes will come from income or carry alone.
While McDonagh expects US Treasuries to face increased headwinds in 2021, he notes it is difficult to fully take into account the economic implications of the Covid-19 vaccine roll out.
While the pandemic affected the EMD universe as much as it did every asset class, and at a greater level than the 2008 crisis, McDonagh also notes the shock was less for emerging than developed markets. He attributes this to lower debt levels in many emerging markets ahead of the crisis.
China is a key component of the recovery in EMD and EMCD, he says, noting the economy is of greater significance and influence on emerging markets than the US. “Some 65% of the increase in Chinese imports since May 2020 have come from emerging markets,” he cites, pointing out this highlights the shift in dependencies in the region.
In addition, he says: “typically a crisis of growth in emerging markets involves a balance of payments issue – not so this time. While there has been a significant weakening in exchange rates since the crisis began, it is not the reason for a decline in import demands.” This is why McDonagh and the Insight team believe companies across such regions are well situated to likely rebound from the crisis. It is also why defaults in the EMCD universe may be far less than in other crisis and in comparison to the US, he adds.
Rodica Glavan, head of emerging market corporate debt at Insight, forecasts defaults in EMCD to stay below 4% for 2020 – almost half what the US high yield market is expected to reach by year end. By comparison, according to Insight’s figures, EMCD defaults reached 5.1% during the difficult 2015-16 period and 10.5% in the 2009 crisis.1
Glavan points out net leverage across emerging markets is lower than developed markets for both high yield and investment grade-rated companies (See Figure 1). The lower debt levels of companies, the refinancing activity last year among EM corporates when conditions were more favourable and the supportive measures being taken by governments around the world are all positives for the asset class for the year ahead, she says. “Encouragingly, the EM corporate recovery rate has been at 43% year-to-date, relatively high both by historical standards and compared to US HY, where it is around record lows of around 15%,” she adds citing stats from JP Morgan as of August 2020.
This is not to say the potential for returns and default risk is homogenous across the asset class. There are regions she sees as problematic, such as Turkey, South Africa and Brazil. The wide discrepancies in fiscal deficits will be a key determent of returns in EM over the few years, McDonagh adds.
Positive influences in 2021
Glavan notes that with the US election over, the outcome may offer further positives for EMCD in 2021. Positively influencing prices in the year ahead is a more predictable trade policy from the new US administration, she states. While Glavan doesn’t believe Joe Biden will reverse some of the protectionist policies already in place, he is likely to adopt a more cooperative approach across emerging market governments, especially China. US Treasury yields are also likely to stabilize on expectations of less fiscal expansion, resulting from the divided US Congress, she says. The EMD team at Insight also believes the US dollar is also likely to be weaker in the year ahead on the back of less need for the safe haven currency in the face of increased positive news regarding vaccines as well as increased stimulus to counterbalance the expected lower fiscal stimulus.
1Source: Insight as of November 2020.
Carry: The cost or benefit of owning an asset.
Leverage: The amount of debt used by a company to finance its assets.
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