Article
Emerging market (EM) corporate bonds denominated in hard currency should be included in every portfolio – and not just because of the potential for attractive returns.
May 5, 2021
Hard currency EM corporate bonds have displayed stellar performance in the past and continue to offer attractive investment opportunities worthy of consideration as part of a portfolio’s strategic asset allocation (SAA). EM corporate bonds offer a broader and more diversified investment universe than sovereign bonds in terms of sectors and issuers while also featuring a significantly lower duration. In addition, willingness to pay tends to be greater in the case of EM corporates compared with sovereign bonds.
A comparison of EM corporate bonds with their US counterparts reveals that here, too, the former are characterized by interesting performance in terms of fundamentals and valuations that should no longer be overlooked. EM corporate bonds exhibit lower net leverage, for example. At the same time, investors are compensated with higher risk premiums. A J.P. Morgan comparison of the high-yield segment (CEMBI HY) with its US peer shows that historical and expected payment default rates are lower and recovery values are similar. If we now compare their sound fundamentals with valuation levels, EM corporate bonds continue to score points thanks to the higher risk premiums mentioned earlier. The risks involved when investing in emerging markets do need to be taken into account; nevertheless, investors continue to be compensated very well, in our view.
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A focus on hard-currency bonds is worth considering due to several factors that point in their favor. Hard-currency bonds are internationally standardized owing to jurisdiction based on New York or English law. By contrast, local-currency bonds are covered by the relevant domestic legislation. When focusing on investments in corporate bonds with a risk premium (credit), it should also be noted that risk premiums are generally significantly higher for issuers in the international capital market compared to those in domestic markets. In addition, the local-currency market is dominated by government bonds, and it is the base currency that accounts for the lion’s share of performance. This means that those investing in local-currency bonds must have a very firm view on strong EM currencies versus the US dollar. We believe that investments in hard-currency EM corporate bonds constitute a very attractive asset class for credit investors. A dedicated allocation also makes sense given that more than half of global economic output is now generated by EM economies, which are posting above-average rates of economic growth.
Source: Credit Suisse, unless otherwise specified.
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