Junk Status Conceals Gems Among Emerging Corporate Bondsby
Ashmore, Aviva see value in EM high-yield company debt
Fallen angels improve average credit quality of junk bonds
Don’t be fooled by their junk status, many emerging-market corporate bonds are safer than they look.
High-yield notes in developing countries have a better credit rating on average than their peers in advanced nations as a spate of sovereign downgrades last year pushed higher-quality borrowers like Brazil’s Petroleo Brasileiro SA and Russia’s Sberbank PJSC into their fold. That’s prompted investors from Aviva Plc to Ashmore Group Plc to say emerging-market junk bonds offer superior value and it’s time to start buying them again.
Money managers argue the companies are more immune to defaults than their ratings suggest because governments would rush to their rescue in times of distress. That’s a backstop borrowers in richer nations are less likely to get. Of the 20 issuers that missed bond payments this year, only one came from the developing world, Standard & Poor’s said in a Feb. 25 report.
“Emerging-market high yield is now safer than developed high yield,” said Anton Kerkenezov, a corporate debt money manager who helps oversee about $3.5 billion of developing-country assets at Aviva Investors in London. “While there is a lot of concern about defaults in U.S. energy-sector bonds, emerging-market corporates are more resilient.”
The Bloomberg High-Yield Emerging-Market Corporate Bond Index has swelled almost 20 percent by market value in the past 12 months as investment-grade companies from Brazil to Russia joined its ranks amid a plunge in oil prices toward a 12-year low. S&P downgraded about 50 developing-nation companies to junk during that time, with the majority coming from South America, according to data compiled by Bloomberg.
“It’s a good time to find cheap assets,” Nuria Jorba, a credit analyst at Union Bancaire Privee Ubp SA, a wealth manager that oversees $94 billion, said from Zurich. “Recently there has been negative sentiment toward emerging-market corporates, but that doesn’t mean that all of those bonds are at risk of default.”
The inclusion of “fallen angels,” or issuers that lost their investment-grade status but have a low probability of default, has helped to improve the average creditworthiness of the junk universe.
The Bank of America Merrill Lynch High Yield U.S. Emerging Markets Corporate Plus Index is rated three steps below investment grade, one level higher than the bank’s developed-nation speculative bond gauge. Some 22 percent bonds in the developing index are rated one notch below investment grade, compared with 15 percent in the advanced gauge.
The yield spread between the two classes has also narrowed by 39 percent in the past 12 months. Emerging-market junk bonds trade at an average yield of 10.19 percent, compared with 7.82 percent for developed high-yield debt. The gap was 3.94 percentage points a year ago.
“Many EM high-yield issuers are owned fully or partially by their governments, and as a result have been downgraded not for credit deterioration but rather as a result of their respective country’s downgrade,” Brigitte Posch, the head of emerging-market corporate debt at Babson Capital Management in London, said by e-mail on Feb. 24.
Eighty percent of emerging-market speculative-grade energy companies by market capitalization are quasi-sovereigns, meaning they may receive financing help from states and their banks if the oil-price slump hurts their ability to service debts, Jan Dehn, the head of research at Ashmore, said in a research note last month.
Investors have flocked to bonds of Petrobras and Sberbank in the past month following a selloff in January. Yields on Petrobras securities due March 2024 have retreated 2.7 percentage points from a Jan. 20 high to 10.5 percent by 3:18 p.m. in London on Monday. Sberbank’s notes due two years earlier have handed investors returns of 6.9 percent this year, among the most from Russian corporate Eurobonds in a Bloomberg index.
There’s still room for pessimism. Fitch Ratings projected this year that defaults by emerging-market companies will increase as they face dollar-debt repayments of more than $5.6 billion in the next three years at a time when higher U.S. interest rates are reducing investors’ risk appetite. The number of developing-country Eurobonds trading below 60 cents a dollar has more than doubled in the past year.
The concerns are overblown, according to Ashmore’s Dehn.
“EM corporates offer a superior value proposition: far better quality for roughly the same yield,” he said. “Many international investors are now underweight and looking for the right entry point back into the market.”