Corporate Emerging Market Bonds Could See Additional Flows In 2020
Selectively picked short duration EM bonds offer attractive yields, with lower volatility than broad duration bonds
Global markets experienced heightened volatility in 2019. However, despite some headwinds, EM corporate debt proved appealing on a total return basis, with short duration bonds particularly attractive, according to Jupiter Asset Management’s research paper “Emerging Market Debt: investing in a truly diverse asset class”. In the paper, Jupiter offers an in-depth look at the state of EM debt, and an outlook for opportunities in 2020 with an eye on the Middle East.
Jupiter’s Fixed Income team believes that the EM debt asset class is likely to continue to perform well on a risk adjusted basis due to attractive yield compared with developed markets, growth in emerging economies, a significant dedicated investor base and solid opportunities for diversification. The corporate and sovereign bond universes could also to see additional flows from passive ETFs in 2020.
In the Middle East and Africa region, the Jupiter team believes select credits provide exciting opportunities, with corporate bonds playing a key role while spreads converge even closer to the sovereign in the region. A recent example of this: in February, the Abu Dhabi National Energy Company (TAQA) received an offer from its 74% shareholder, Abu Dhabi Power Corporation (100% owned by Abu Dhabi government), to increase its equity ownership of the firm to 98.6%. The transaction will likely increase TAQA's strategic importance to the sovereign, implying an even closer relationship to Abu Dhabi than that which already exists which could lead to some upward migration in TAQA's credit ratings upon completion of the proposed transaction.
“When allocating between EM corporates and sovereigns, investors should consider the fact that corporates typically offer a higher spread to sovereigns. For investors, this provides an opportunity to lock in higher yield to maturity. Credit risk can be higher for corporates but, through bottom-up credit analysis of the financial statements, investors can form expectations on the repayment capacity of the company and attractive opportunities can be uncovered.” said Alejandro Arevalo, Fund Manager, Fixed Income at Jupiter Asset Management.
Arevalo continued: “The Middle East region has two major risks. First, geopolitical risks are high and can often generate negative headlines creating volatility in the asset class. Second, the major economies in the region are undergoing a reform and fiscal consolidation agenda, which are difficult to implement and create uncertainty.”
“We also see opportunities in shorter duration bonds and holding them to maturity to lock in the yield to maturity. EM short duration bonds offer a high spread with limited volatility risk, which makes them an attractive cash proxy. Based on historical volatility of the last 10 years, we have calculated that the volatility of a 10-year bond is 4x higher[1] than a bond with a maturity of 3 years,” Arevalo added.
The major uncertainty around performance in 2020 is coronavirus. While EM debt should be, according to Jupiter, diversified enough to weather the virus, some economies could be adversely affected, and there are a lot of unknown factors around how supply and demand chains will be impacted. Meanwhile, a number of emerging markets-specific issues may come back on the agenda in 2020 – for example, the high debt levels of Argentina, Lebanon and Zambia, and the pick-up in corporate defaults in China. However, given the long-term attractive risk return on the EM debt asset (in particular hard currency EM debt), the team believes that episodes of volatility, while negative on the surface, could in fact create attractive entry points for dedicated investors.
