This is a story about resilience and the global economic recovery. The world’s emergence from the pandemic has unleashed pent-up demand for both goods and commodities. Subsequently, the outlook for emerging markets has improved significantly, benefiting emerging market bonds.
It is worth noting, however, that emerging market bonds are not a single asset class. Rather they are a collection of different asset classes, which include both corporate and sovereign bonds and can be invested in both hard currency – US dollars and euros, for instance – and local currency. Both asset classes require a different approach to gain efficient and effective exposure. On the one hand, active selection when managing credit risk is important for emerging market corporate bonds, while on the other hand, diversification is a more pressing issue for emerging market sovereign bonds.
Emerging market corporate bonds
When it comes to emerging market corporate bonds, careful credit selection is incredibly important. Emerging market companies have seen their earnings improve, which has allowed them to deleverage and strengthen their balance sheets. Subsequently, they have been able to lengthen the maturities of the bonds they issue because their credit quality has improved. Leverage ratios have started to fall after they increasing in 2020, and they are expected to fall to levels last seen in December 2019. This would indicate that the risk of default has declined from last year.
Emerging market corporate bonds on average also offer a higher yield than credit with the same rating in developed markets.
Each emerging market country is also unique. They differ from each other in terms of their economic fundamentals, which has an impact on their individual credit markets. Consequently, the opportunities available to investors are incredibly diverse. This is a market where active selection can really pay off. There are many potential rising stars among emerging market corporate bonds, but at the same time prudent selection to avoid the potential fallen angels is also needed. Meanwhile, in the more mature emerging market sovereign bond market, the opportunity lies in being able to get diverse exposure across the asset class.