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In our latest interview, Senior Portfolio Manager Andreas Fischer explains how investment-grade emerging-market bonds have been affected by the crisis and describes the investment opportunities presented by the current situation.
August 19, 2020
My work has to do with corporate bonds from EM countries that are viewed as sound by the major rating agencies and thus carry a good, investment-grade (IG) rating. This means first and foremost that the risk of default is considered very low. IG ratings are attained by companies that do business prudently, possess ample liquidity and a robust business model, and operate in a stable environment. In particular, these criteria cause companies in countries with low sovereign ratings to be completely omitted from the IG segment.
Many IG issues are bonds issued by large companies that generate part of their revenue transregionally or globally, stem from countries with a reliable market structures and a consistent regulatory environment, and have an accordingly sound credit history. Many of those companies also are partly government-owned.
The pandemic hit the financial markets just as quickly and surprisingly as it hit every other area of society. There was no time for nuanced considerations and judgments. Thinking accordingly transpired in broad categories, and there was lots of measuring-everything-by-the-same-yardstick going on. Here is what this meant specifically: EM countries are generally considered to be more unstable and more vulnerable to crises because their institutions – governments, administrative bodies, and markets – are often less well-established. Spreads (i.e. yield differentials, a market-based measure of relative risk) against comparable bonds from industrialized nations accordingly widened sharply across all regions, sectors, and rating categories. This was due on the one hand to risk assessments for EM countries being suddenly ratcheted much higher and, on the other hand, the major central banks in the industrialized world – led by the US Federal Reserve (the Fed) – quickly and aggressively moving to support local markets and thus sending a sign of relief.
The fact that this also affected IG bonds in the EM segment and in EM countries that quickly got the pandemic under control opens tangible opportunities for investors.
"The credit spreads on such bonds against developed-market bonds present attractive opportunities."
Many investors prejudge IG EM bonds as being like any other run-of-the-mill EM bond.
In other words, they view them as bonds that carry the typical risks associated with emerging economies. In many cases, though, their credit quality actually bears a closer resemblance to that of IG bonds from developed economies. Like their developed-market counterparts, IG EM bonds are issued by financially sound companies that operate internationally. Moreover, some of those issuers are domiciled in countries that have coped well with the crisis. I am thinking here of South Korea or Singapore, for example. The credit spreads on such bonds against developed-market bonds present attractive opportunities. Furthermore, the extraordinary actions taken by the Fed and other central banks have greatly reduced credit risk premiums on developed-market bonds, widening the yield differential between the two segments. This effect will not last forever. There will be a convergence that will move valuations back toward their fundamentally justified levels. This means that IG EM bonds are likely to rally against developed-market bonds eventually, meaning that now is an attractive entry point.
On the one hand, certain countries and regions have been hit harder by the crisis than others. The pandemic continues to rage in Latin America, for instance, whereas many Asian countries have been more successful in containing COVID-19 due to their prior experience with virus outbreaks or, for instance, due to an existing cultural affinity for face masks. Since those countries were all thrown into the same bucket in the heat of the somewhat hasty market reaction, this surely opens up opportunities here for discerning investors. On the other hand, it is also about sales markets. To cite an example, China ranks among the world’s largest buyers of raw materials. As soon as its economy regains momentum, its suppliers will follow suit. Sectors like metals and mining, oil and gas, and industrial manufacturing are bound to profit worldwide, though a renewed dip in world economic activity could deal another setback here as well.
"We deliberately favor regions, sectors, and even individual issuers that look especially interesting to us, be it from a valuation perspective or because we are counting on a specific rally driven by certain isolated factors."
We consider the IG EM bond segment in general to be interesting for investors relative to comparable developed-market bonds mainly for valuation reasons. However, we employ active management to effectively exploit the differences between regions or sectors in a portfolio. This means that we deliberately favor regions, sectors, and even individual issuers that look especially interesting to us, be it from a valuation perspective or because we are counting on a specific rally driven by certain isolated factors.
The IG EM bond asset class is very heterogeneous. It includes, for example, issues from Russian commodity titans, Mexican automotive suppliers, and Indonesian banks. It is immediately obvious that big differences in yield and risk expectations exist here.
As I said before, this asset class was hit hard by the coronavirus crisis, but the crisis is not entirely over yet. Further turbulence likely lies ahead. This is why certain investors are probably still waiting on the sidelines, which makes this an especially attractive entry point for those who are not daunted by potential volatility. Moreover, an active approach enables investors to specifically seize the more interesting opportunities.
General diversification and yield rationales also make a case for investing in IG EM bonds. We continue to note that many investors are underinvested in this segment. Anyone who has always wanted to rectify this and would like to seize the corresponding yield and diversification opportunities has an attractive possibility to do that now.
Andreas Fischer (MSc, CFA), Director, is a Senior Portfolio Manager for Emerging Markets and a member of the Emerging Markets Strategy Group.
Prior to joining Credit Suisse Asset Management in 2012, he was responsible for hedging and overlay strategies as well as asset allocation monitoring at Clariden Leu Asset Management in Zurich. Furthermore, as the portfolio co-manager, Andreas was in charge of the Clariden Leu Core Plus funds. He started his career at Basellandschaftliche Kantonalbank before taking up a position as a portfolio manager at Bank J. Safra Sarasin. Additionally, he worked in London for London & Capital Asset Management from 2006 to 2011, managing absolute-return strategies including emerging-market bonds.
Andreas holds a master’s degree in Finance from Birkbeck University of London and is a CFA charterholder.