EM corporate bonds: strategic or tactical?



Emerging market (EM) corporate bonds offer unique alpha opportunities with good yield for investment grade-style characteristics. In a world of low inflation and low growth, EM corporates should stand out for their ability to generate low-volatility returns. For these reasons, we think EM corporate bonds warrant a strategic allocation.

For investors looking for low volatility yield, emerging market corporates can be an attractive place to invest. The asset class is 60% investment grade (IG), with low volatility and low drawdowns (compared to other credit asset classes). Most importantly, with over 1,200 bonds from 52 countries across 12 sectors in the JPM CEMBI index, the asset class offers investors a wide range of opportunities. For active managers like us, there are many great alpha opportunities. In addition to capturing positive market performance, our investment approach also seeks to protect investors on the downside.

EM corporate credit is more than just ‘sovereign-plus’

Emerging market corporate credit grew out of the sovereign bond market and has expanded significantly in the past decade. Indeed, the outstanding notional value of EM corporate debt is now more than double that of sovereign debt in hard currency terms*.

In its infancy, the asset class was centred around its sovereign parent. Many EM companies started off with some level of state sponsorship, so a natural form of analysis was to evaluate the issuer as an extension of its sovereign parent. As state-owned enterprises were privatised or spun-off, EM companies sought to diversify their funding base and the asset class started to grow. Almost two decades later, the EM corporate debt asset class is not just larger but also more diverse than EM sovereign debt.

It is also an investor-friendly asset class. For example, more than 70% of issuers adhere to either International Financial Reporting Standards (IFRS) or US GAAP**, making financial statement analysis more straight-forward, and making company comparisons across geographies easier to do. In addition, a number of countries (eg, Mexico, Brazil, China) have accounting rules that are very similar to the IFRS/US GAAP, accounting for close to 15% of additional NAV. Finally, more than 85% of EM corporate issuers are publicly listed, which adds a layer of transparency and corporate governance.

*Hard currency = external debt issued mostly in US.
**Generally Accepted Accounting Principles developed by the Federal Accounting Standards Advisory Board of the United States.

The asset class is very diverse, and can offer alpha opportunities
EM economies have grown in strength and now represent over 57% of global gross domestic product, on a purchasing power parity basis (IMF’s October 2016 World Economic Outlook). While in the past, emerging markets were associated exclusively with issuers reliant on natural resources, such as oil, iron ore or agricultural products, the market has changed significantly. As countries grew, industries were also strengthened, leading to a wider and deeper issuer base. This, as noted above, has naturally coincided with the steady growth in EM bond markets, resulting in a diverse set of participants and issuers across sectors from financials and utilities to transport and industrials.

The list of example companies ranges from systemically important state-owned enterprises, such as Petrobras in Brazil or China State Grid, to multi-nationals such as JBS, a Brazilian meat processor (the largest in the world) or Hyundai Motor, the Korean auto manufacturer. There are companies whose businesses are focused almost entirely on exports, such as Brazil’s Fibria (pulp and paper), while others have a domestic focus, such as Alibaba, the Chinese e-commerce company. Issuance can also range from companies with foreign currency exposure, to those without; some companies can even hedge their currency risk.

For investors wanting to express a view, EM corporates offer a large, diverse set of issuers with different macro, country, sector, duration, and credit drivers. As a result, there are many opportunities to generate alpha.

Do opportunities in EM corporates warrant a strategic allocation?
The EM corporate debt asset class is growing, not shrinking. Debt from EM corporates has outpaced EM sovereigns, and now represents 67% of total EM debt compared with 47% ten years ago. Long-term fundamental improvements in EM economies have also improved the credit quality of the asset class. In 2016, 64% of the corporate debt stock was investment grade compared with less than 40% back in 2000.

Today, there are many developed market companies that have more underlying exposure to emerging markets than some EM companies; often, when you buy corporate bonds from emerging markets, you are buying the debt of very solid companies — they are just based in the ‘wrong’ zip/postal code. Many of these companies are also assuming a more significant role in global corporate consolidation, often acquiring developed market competitors.

EM bonds form an investment grade asset class that offers lower volatility and higher yields than comparable developed market bonds, but with additional diversification benefits not readily available in the developed world. EM corporate bonds have traditionally offered relatively high returns, but have low correlation to certain other bond markets such as developed market government bonds. Finally, as the chart in Figure 1 illustrates, the yield on EM corporate bonds continues to be among the highest currently available in fixed income markets. For these reasons, we think the asset class merits a strategic asset allocation.

Figure 1: EM credit offers high income, as well as diversification benefits

Source: Thomson Reuters Datastream, JP Morgan, Janus Henderson Investors, yields as at 31 July 2017
Note: Euro Corp IG: JP Morgan Maggie, US Corp IG: JP Morgan Juli ex EM, EM Corp IG: JP Morgan CEMBI Broad Diversified (IG), Euro Corp HY: JP Morgan Euro HY, EM Corp: JP Morgan CEMBI Broad Diversified, US Corp HY: JP Morgan HY. 5Y UST: US generic 5Y Treasury, 5Y Bund: German generic 5Y bund.

The near-term outlook is benign
The broader EM fixed income market strength has been underpinned by sustained, recurring inflows into the asset class. We believe that these inflows are from investors in search of low volatility yield. Consistent inflows of US$1-2 billion per week since June 2016 (save a few weeks during and after the US presidential election) would imply that inflows are strategic, and likely to be broad-based; possible sources are from Asian life insurance companies, sovereign wealth funds, and pension funds. With a nascent exchange-traded fund (ETF) market for EM corporates, we believe that inflows into funds are likely to stay strong, extending the current positive technical environment.

The chart in Figure 2 shows the strong recent relationship between inflows and the JP Morgan CEMBI yield. Yields have reflected flows fairly well. We think the market has room to continue to perform.

Figure 2: capital inflows into EM driving yields lower

Source: BoA Merrill Lynch, JP Morgan, Janus Henderson Investors, as at 26 July 2017
Note: Inflows into EM corporate bonds and yield to worst on the JP Morgan CEMBI index

In addition to strong technicals, the overall macro backdrop has been benign. Unprecedented central bank intervention around the world has generally benefited markets. It has created low volatility, which has been a boon to investors across many asset classes. The lack of meaningful systemic issues has also extended the current bull market rally into its ninth year. But along with market stability, we have also seen low rates, low inflation, and rather unsurprisingly, low growth. These factors have persisted in the US and across most countries in Europe, along with a handful of emerging countries such as Brazil. But there have also been countries that have benefited from this, such as China and Chile, two exporters with strong fiscal accounts.

Active managers can outperform the market
We believe the best investment approach is a holistic one, with consideration of both macro and micro factors. We manage our portfolio in an 'index aware' manner, rather than aiming to replicate the index. Crucially, we take an active role in managing the downside risk and are not bound to any particular country, sector, duration or position weights. We view each investment as a sum of its parts, paying attention to several factors concurrently. We believe this holistic approach provides a well-rounded, thorough view on the investment.

As the EM corporate asset class was borne out of a sovereign strategy; many peers still primarily rely on country views to anchor their investment decisions. Our strategy is instead underpinned by credit-intensive, fundamental company analysis. We then use macro inputs to help us with the timing of our investments, paying attention to market liquidity and technicals as well. In our experience, country risk alone is inadequate in assessing EM corporates, which is why we invest in companies, rather than countries.

The growth of EM corporate credit has been propelled by privatisation, structural growth, and international merger and acquisition (M&A) activity. In addition, financial disintermediation has and will continue to increase the breadth of issuers across countries and sectors, and across the credit curve. The investment opportunities are both numerous and diverse. Also, with EM economies growing stronger, credit ratings have improved and investor sentiment has turned more positive around this fast growing asset class.

We believe the Janus Henderson EM credit approach is best suited to capture opportunities in this dynamic market. Our performance reflects our unique investment philosophy, with top tier returns and low volatility (see Figure 3 below).

Figure 3: EM corporate bond funds: peer group returns since November 2014

Source: Janus Henderson Investors, Morningstar, as at 31 July 2017
Note:  Peer group derived from the official Morningstar peer group by adjusting for specialist funds (High Yield/High Grade/Distress Debt); cumulative returns since strategy inception on 5 November 2014; performance is for the A share class, net of fees; benchmark is the JP Morgan Corporate Emerging Market Bond Index (CEMBI) Broad Diversified. Past performance is not a guide to future performance.

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

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Janus Henderson Horizon Emerging Market Corporate Bond Fund

This document is intended solely for the use of professionals and is not for general public distribution.

The Janus Henderson Horizon Fund (the “Fund”) is a Luxembourg SICAV incorporated on 30 May 1985, managed by Henderson Management S.A. Any investment application will be made solely on the basis of the information contained in the Fund’s prospectus (including all relevant covering documents), which will contain investment restrictions. This document is intended as a summary only and potential investors must read the Fund’s prospectus and key investor information document before investing. A copy of the Fund’s prospectus and key investor information document can be obtained from Henderson Global Investors Limited in its capacity as Investment Manager and Distributor.

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Copies of the Fund’s prospectus and key investor information document are available in English, French, German, and Italian. Articles of incorporation, annual and semi-annual reports are available in English. Key Investor document is also available in Spanish. All of these documents can be obtained free of cost from the local offices of Janus Henderson Investors: 201 Bishopsgate, London, EC2M 3AE for UK, Swedish and Scandinavian investors; Via Dante 14, 20121 Milan, Italy, for Italian investors and Roemer Visscherstraat 43-45, 1054 EW Amsterdam, the Netherlands. for Dutch investors; and the Fund’s: Austrian Paying Agent Raiffeisen Bank International AG, Am Stadtpark 9, A-1030 Vienna; French Paying Agent BNP Paribas Securities Services, 3, rue d’Antin, F-75002 Paris; German Information Agent Marcard, Stein & Co, Ballindamm 36, 20095 Hamburg; Belgian Financial Service Provider CACEIS Belgium S.A., Avenue du Port 86 C b320, B-1000 Brussels; Spanish Representative Allfunds Bank S.A. Estafeta, 6 Complejo Plaza de la Fuente, La Moraleja, Alcobendas 28109 Madrid; Singapore Representative Janus Henderson Investors (Singapore) Limited, 138 Market Street, #34-03 / 04 CapitaGreen 048946; or Swiss Representative BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich who are also the Swiss Paying Agent. RBC Investor Services Trust Hong Kong Limited, a subsidiary of the joint venture UK holding company RBC Investor Services Limited, 51/F Central Plaza, 18 Harbour Road, Wanchai, Hong Kong, Tel: +852 2978 5656 is the Fund’s Representative in Hong Kong.

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Specific risks

  • This fund is designed to be used only as one component in several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.
  • The value of a bond or money market instrument may fall if the financial health of the issuer weakens, or the market believes it may weaken. This risk is greater the lower the credit quality of the bond.
  • Emerging markets are less established and more prone to political events than developed markets. This can mean both higher volatility and a greater risk of loss to the Fund than investing in more developed markets.
  • If the Fund or a specific share class of the Fund seeks to reduce risks (such as exchange rate movements), the measures designed to do so may be ineffective, unavailable or detrimental.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Any security could become hard to value or to sell at a desired time and price, increasing the risk of investment losses.

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