Broadening credit opportunities through emerging market corporate debt

Broadening credit opportunities through emerging market corporate debt

03-07-2020 | Interview
It is a misperception that emerging market companies are small, risky and single-focused. The debt issued by these businesses represents an asset class that offers access to some world-class companies.
  • Reinout Schapers
    Director Emerging & Global Credit

Speed read:

  • The hard-currency EM corporate debt market opportunity is sizeable
  • Investors benefit from access to large, diversified world-class companies…
  •  …and the low correlation between developed and EM credit segments

How do you approach investing in emerging market credits?

“The way we approach emerging market credits is pretty similar to how we approach high yield and global credit in general. In other words, we evaluate individual credits, which differs from the typical approach of starting from a country perspective. So, we look at individual credits and employ a thorough bottom-up selection process. We then combine this with our top-down view, which reflects our views on credit markets as a whole, how emerging markets fit into this picture, what our expectations are, and thus how much risk we want to take. For Robeco, our emerging markets strategy is therefore complementary to our holdings in developed market credits.”

This is an extensive market, spread across geographies. How are you able to maintain bottom-up coverage in all emerging markets?

“We don't necessarily cover all emerging markets. Our approach is to stick to the higher-quality countries, where there is a broad corporate market which provides relatively easy access to these economies. For an emerging corporates fund – at least the way we run it – this also means sticking to countries where we think it is responsible for corporates to issue dollar-denominated debt. So, you narrow it down to around 15 countries worldwide – which in itself is already a choice to simply not cover everything.”

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What’s the interplay between corporate risk and country risk in emerging markets, and how do you assess and manage these considerations?

“In principle, the corporate analysis comes first. But in emerging markets, corporate risk is influenced by the country. This influence has multiple facets, one of which is currency. If you borrow using dollar-denominated debt and you operate in local currency, then large moves in the currency will have an impact on your business. Another facet is changing policies: policymaking in emerging markets tends to be a little more volatile than in developed markets, and that has an impact on the business. Also, corporate governance standards are usually lower. And then, of course, the underlying volatility of the country is reflected in the performance of corporate debt. So, we do take all of this into account.”

“Above all, it is extremely important to us that a company is healthy in itself. We generally stay away from highly leveraged companies that rely on implied government support. We want solid businesses. It's really the business that makes us decide we want to be in a certain country, not the other way around. We wouldn’t simply add, say, a basket of Indian names because we like the current dynamics in India. Our selection criteria require the issuers to be good companies. And that is the very basic principle of the fund.”

“It's important that the strategy is slightly more conservative than that of many of our peers. We place a lot of emphasis on capital preservation and we've never had a default in the portfolio.”

With globalization, there is a blurring of lines between emerging market and developed market activity. How do you take this into account in your emerging markets credit selection?

“We've seen in the last 10, 15 years that emerging market and developed market companies have moved closer to each other. Developed market corporations have invested heavily into emerging markets because that is where the growth is. So you see US businesses moving into emerging markets, but also European companies that have large exposures in, for example, Latin America. At the same time you see the larger emerging market companies wanting to diversify away from being a purely single-country business, and they venture into multiple emerging markets, and also into developed markets.”

“It is a given that the lines are blurring. If you have a developed market company with a large revenue and earnings base in emerging markets, why should we see that as less emerging than a business which is domiciled in an emerging country, but that derives, say, over 50% of its revenues from developed markets. So, where the emerging market bond index looks at country of domicile, we look simply at what the earnings sources are. And that to us determines whether we see it as emerging or developed credit.”

How would an emerging markets strategy fit into a global portfolio? Why would an investor need a specific pocket for emerging markets?

“There are two important reasons, with one being diversification. By moving into emerging corporates, you broaden your opportunity set to an asset class that gives access to some world-class companies. It is a misperception that emerging market companies are small, risky, single-focus companies. Yes, they're still there. But in general, these are large, well-diversified, well-run companies. And it is also the way to go if you want emerging market exposure in hard currency, given that fewer better-quality sovereigns are now issuing dollar-denominated debt.”

“The second reason is the lower correlation. While credit markets are correlated, the correlation between developed markets and emerging market corporates is much lower. And there's good reason for that: the economic cycle in emerging markets can be completely disconnected from the European or the US economy from time to time.”

What is your outlook for emerging market credits?

“We’re quite constructive on all credit markets, essentially. Despite the recent rally, markets remain cheap. Global savings rates remain high and there is a massive amount of support from governments and especially the Western central banks, which means that there is demand for credit. And it also means that there is demand for emerging credit. Given the fact that there are some really good companies being offered at very attractive spreads, I think emerging corporates is a market that has sufficient room to perform very well, for at least for the next 12 months.”
This is an extract from the interview.
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