AFTER A DECADE OF STRONG PERFORMANCE, THE ASSET CLASS DESERVES A SERIOUS LOOK.
• Emerging markets (EM) corporate debt is now a larger market than U.S. high yield or EM sovereigns, with over USD $2 trillion of bonds across 50 countries.
• Thanks to an average BBB- rating and generally healthy fundamentals, the asset class generated an 8.5% annualized return over the past decade, with modest drawdowns.1
• A scarcity of dedicated EM corporate investors, inefficient markets, and labor-intensive research needs create alpha opportunities across cycles, in our view.
• It is difficult, if not impossible, to assess an EM corporate bond issue without understanding the home country’s politics, economics, and equity markets. In-depth fundamental research is vital.
Corporate debt is the fastest-growing area of hard currency emerging markets (EM) debt, with almost USD $2.2 trillion outstanding and new issuance averaging 15% of debt outstanding per year since 2011. The asset class generated strong risk-adjusted returns over the five years ended December 31, 2018, due to the broadly healthy balance sheets of most EM companies and a tilt toward investment-grade Asian markets. During 2018, when other emerging markets assets—particularly equities and local currency debt—suffered notable sell-offs, the EM corporate market proved relatively resilient.
Going forward, we see sustained opportunities in EM corporate debt, as new issuers continue to come to market and the asset class becomes more widely held among institutional investors. Additionally, we believe the asset class offers many opportunities for bottom-up fundamental managers to generate meaningful alpha for their clients.
As of December 31, 2018, the EM corporate debt universe encompassed over 1,300 companies across 50 countries. Since 2011, the market has grown an average 15% per year, fueled by numerous debut issuers, unlike the stable-to-shrinking U.S. high yield and EM sovereign debt markets.
Figure 1: Size of Global Bond Sectors EM debt offers investors a large and diverse opportunity set | Debt outstanding, as of April 30, 2019
Sources: J.P. Morgan, Bloomberg Barclays, MSCI. EM Sovereign: J.P. Morgan Emerging Markets Bond Index Global; EM Corporate: J.P. Morgan Corporate Emerging Market Bond Index Broad Diversified; EM Local: J.P. Morgan Government Bond Index—EM Global Diversified; U.S. Treasury: Bloomberg Barclays U.S. Aggregate Index—Treasury; U.S. IG Corporate: Bloomberg Barclays U.S. Corporate Investment Grade Index; U.S. High Yield: Bloomberg Barclays U.S. High Yield Index. EM Equity: MSCI Emerging Markets Index. Bloomberg Index Services Ltd. Copyright © 2018, Bloomberg Index Services Ltd. Used with permission. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI. Information has been obtained from sources believed to be reliable but J.P. Morgan does not warrant its completeness or accuracy. The index is used with permission. The Index may not be copied, used, or distributed without J.P. Morgan’s prior written approval. Copyright © 2018, J.P. Morgan Chase & Co. All rights reserved.
Higher credit quality, USD denomination, and a structural tilt toward Asia made EM corporate debt among the most defensive EM assets during recent market corrections. In 2018, for example, the J.P. Morgan CEMBI Broad Diversified declined 2% while most other EM assets declined 5%–15%.
Figure 2: Rolling 6-Month Correlations Of Credit Spreads | Correlations with other risk assets increased in the wake of the global financial crisis. June 30, 2002 through April 30, 2019
Sources: J.P. Morgan. EM High Yield: J.P. Morgan Broad Diversified High Yield Index. U.S. High Yield: J.P. Morgan Domestic High Yield Index.
EM Corporates Offer Diversification Potential
While many institutional investors currently do not have strategic allocations to EM corporate debt, the asset class offers meaningful potential diversification benefits relative to many widely held institutional assets, particularly commodities, core fixed income, and U.S. equities.
Figure 3: Risk & Return Profiles | EM corporate bonds have featured relatively strong risk-adjusted performance. April 30, 2009 through April 30, 2019
Past performance is not a reliable indicator of future performance. | Sources: J.P. Morgan, MSCI, and Bloomberg Index Services Ltd. Copyright © 2018, Bloomberg Index Services Ltd. Used with permission. U.S. investment grade = Bloomberg Barclays U.S. Investment Grade Index; EM sovereign = JP Morgan EMBI Global Index; EM corporate = J.P. Morgan CEMBI Broad Diversified; U.S. High Yield = Bloomberg Barclays U.S. High Yield Index; Euro High Yield = Bloomberg Barclays European High Yield Index; EM equity = MSCI Emerging Markets Index.
In the wake of the 2007-2009 global financial crisis, correlations with other risk assets increased, impacted by the U.S. Federal Reserve’s quantitative easing (QE) polices. However, now that QE and balance-sheet stimulus are being unwound, correlations have fallen to multiyear lows. We believe that over time they will revert to pre-crisis levels. In addition, the U.S. is approaching the late phase of the economic cycle while emerging markets overall are in their early cycle. In our view, this means correlations are likely to decline further.
In addition to generating attractive risk‑adjusted returns at the index level, a closer examination of the EM corporate debt universe shows that different regions historically have offered significantly different risk/return profiles, allowing investors to calibrate their exposures throughout a market cycle.
Figure 4: EM Corporate Debt Ownership | Different buyer bases potentially allow managers to exploit regional inefficiencies. | Debt Outstanding, as of October 31, 2018
Source: J.P. Morgan
Very different domestic buyer bases also potentially allow active managers to exploit technical inefficiencies across regions. In Asia, large numbers of local buyers historically have tended to provide support during market sell-offs, generating a more defensive return profile. In Latin America, by contrast, foreign investors—including U.S. crossover investors—dominate the market, making for more frequent technical dislocations.
What We’re Watching Next
In our view, the past few years have demonstrated that EM corporate debt is an under-owned asset class that offers potentially attractive risk‑adjusted returns at the index level as well as many potential opportunities for outperformance through security selection. Over time, we expect the asset class will become more widely embraced by institutional investors as the U.S. high yield market shrinks and the size and depth of the EM corporate opportunity set become better understood.
However, we believe it is difficult, if not impossible, to fully assess an EM corporate bond issue without understanding the home country’s politics, economics, and equity markets. A commitment to in-depth fundamental research is critical to identifying alpha opportunities and evaluating ideas across regions as the opportunity set shifts. A truly global trading platform also can help managers recognize potential price dislocations while ensuring they are adequately compensated for providing liquidity to the market and can execute trades during local market hours around the world.