Emerging Market Corporate Debt: Taking Stock of a Strong Second Quarter

July 18, 2014 11:52 AM
By Jerald M. Lanzotti, CFA

Emerging market corporate debt remains one of the last bastions of incremental yield pick-up in the capital markets.  

Historical experience makes one cautious of over-optimism in the emerging market (EM) economies.  But there was something to celebrate in the second quarter of 2014, as EM corporate debt provided one of the strongest performance stories in the fixed-income asset class,1 outperforming both U.S. high-yield bonds2 and U.S. investment-grade bonds.3  Even more remarkable, this performance occurred during a time of headlined geopolitical risk—typically something that would put a crimp in EM sales of any category. What lay behind the strong relative performance of the period?   

Speaking only of past performance and not promising positive momentum going forward, there were a number of factors at work in the second quarter and, in fact, the first six months of the year. 

Although central bank policy is diverging globally—with some institutions raising interest rates and others lowering them—investors are still operating in a generally low interest-rate environment that offers little opportunity in terms of yield. Moreover, spreads between risky and so-called “risk-free” debt are narrowing, reducing incremental yield in all fixed-income categories. Nonetheless, yields on EM corporate bonds remained attractive on a relative basis during the period.  

When investors are of one mind, it takes a lot to divert their attention. In this case, the search for yield—"any yield," as one investor put it—almost overrode the headline risk, first about Russia and Ukraine, and then about Iraq. Moreover, valuations were compelling in the Russian corporate market, providing a potential investment opportunity for those willing to take on risk. 

Supply and Demand
The total dollar value of EM corporate debt deals in the first six months of the year (as of June 19, 2014) was $284 billion, according to Dealogic, the highest year-to-date total since that firm began keeping records in 2000. There were peaks and troughs of debt issuance over the period, as geopolitical risks affected investor sentiment. But, invariably, investor appetite returned. Institutional demand was particularly strong, as banks, pension funds, and insurance companies added a diversified array of bonds to their portfolios in order to meet tighter regulatory requirements. 

The pipeline of EM corporate deals going into the autumn appears strong as companies will likely continue to take advantage of low interest rates to raise capital. The large size of the prospective deals, the prevalence of longer-dated maturities, and the largely investment-grade quality of the issuers are all positives for the market. Narrowing spreads, however, are an indication that valuations are becoming stretched. A careful analysis of the fundamentals behind each deal will be even more important over the balance of the year.  


1As measured by the JP Morgan Corporate Emerging Markets Bond Index Broad Diversified.
2As measured by the BofA Merrill Lynch High Yield Master II Constrained Index.
3As measured by the Barclays U.S. Corporate Bond Index.


Past performance is not a guarantee or a reliable indicator of future results. Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that emerging markets corporate bond market will perform in a similar manner under similar conditions in the future. The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall. Investing in international securities generally poses greater risk than investing in domestic securities, including greater price fluctuations and higher transaction costs. Special risks are inherent to international investing, including those related to currency fluctuations and foreign, political, and economic events. The securities markets of emerging countries tend to be less liquid, especially subject to greater price volatility, have a smaller market capitalization, have less government regulation and may not be subject to as extensive and frequent accounting, financial and other reporting requirements as securities issued in more developed countries. Further, investing in the securities of issuers located in certain emerging countries may present a greater risk of loss resulting from problems in security registration and custody or substantial economic or political disruptions. No investing strategy can overcome all market volatility or guarantee future results.
The Barclays U.S. Corporate Bond Index includes all publicly held issued, fixed-rate, nonconvertible investment-grade corporate debt.  The index is composed of both U.S. and Brady bonds.
The BofA Merrill Lynch US High Yield Master II Constrained Index is a market value-weighted index of all domestic and Yankee high-yield bonds, including deferred interest bonds and payment–in-kind securities.  Issues included in the index have maturities of one year or more and have a credit rating lower than BB-/Baa3, but are not in default.  The index limits any individual issuer to a maximum of 2% benchmark exposure. Index constituents are capitalization-weighted, based on their current amount outstanding, provided the total allocation to an individual issuer does not exceed 2%. Issuers that exceed the limit are reduced to 2% and the face value of each of their bonds is adjusted on a pro-rata basis. The face values of bonds of all other issuers that fall below the 2% cap are increased on a pro-rata basis. In the event there are fewer than 50 issuers in the Index, each is equally weighted and the face values of their respective bonds are increased or decreased on a prorate basis.
The J.P. Morgan Corporate Emerging Markets Bond Index Broad Diversified (CEMBI BD) is a market capitalization-weighted index that tracks total returns of U.S. dollar-denominated debt instruments issued by corporate entities in emerging markets countries. The index limits the current face amount allocations of the bonds in the CEMBI Broad by constraining the total face amount outstanding for countries with larger debt stocks.
Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.
Treasuries are debt securities issued by the U.S. government and secured by its full faith and credit. Income from Treasury securities is exempt from state and local taxes. Although U.S. government securities are guaranteed as to payments of interest and principal, their market prices are not guaranteed and will fluctuate in response to market movements. Yield is the annual interest received from a bond and is typically expressed as a percentage of the bond's market price.


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Great article. Should be interesting to see how things shake out Q3 with what seems to be escalating geopolitical risk factors.
Joe, thank you for joining the investment conversation on emerging markets. Please check back for updates as we continue to follow events in future posts.