Traders Eye $100 Billion More Emerging-Market Fallen Angels

  • World-beating returns of EM angels lure NN Group to Aviva
  • S&P, Moody's accelerate downgrades as they assess oil shock

There may be a lot more in store for emerging-market investors who scooped up bargains during a $220 billion purge of investment-grade corporate bonds last year.

A further $100 billion of developing-nation debt faces downgrade to junk this year as Moody’s Investors Service and S&P Global Ratings tally up the effects of the oil shock, according to analysts at Barclays Plc. Bonds demoted to speculative grade, so-called fallen angels, have handed investors returns of 8.6 percent this year, beating indexes of emerging market and high-yield peers, according to Bank of America Merrill Lynch and Bloomberg data.

“In this environment, the downgrades are creating opportunities,” said Anton Kerkenezov, a money manager who helps oversee about $5 billion of emerging-market debt, including fallen angels, at Aviva Investors in London. “When you have a credit that you know is quite stable and solid but has been punished by ratings agencies, you can invest at a cheaper price and wait for a rebound.”

Bonds of companies typically fall after turning into junk credits because of forced sellers, fund managers whose investment rules mean they can’t hold sub-investment-grade debt. That creates a buying opportunity for those who can. While Petroleo Brasileiro SA’s cut to junk by S&P in September initially pushed its bond yields to a record high, they dipped back to pre-downgrade levels two months later.

History suggests fallen angels begin outperforming peers in the two months after they are downgraded, Badr El Moutawakil, a credit strategist at Barclays in London, said by phone May 6. They usually recover most, but not all, of the losses they incurred in the prior four months, he said in research he co-authored in February. Returns this year compare with 6.9 percent overall for emerging-market corporate debt, and 7 percent for U.S. high-yield peers, according to Bloomberg indexes.

Investors seeking alternatives to negative yields in the developed world are able to overlook deteriorating credit fundamentals caused by lower commodities prices because of the low likelihood of default. The global speculative-grade default rate will peak at 5 percent this year before falling to 4.5 percent next year, Moody’s forecast today.

The volume of fallen angels from developing nations has multiplied in the past 18 months as the slide in oil prices and local currencies to multi-year lows drained corporate coffers. For many firms in Russia, the world’s biggest energy exporter, debt refinancing is further complicated by international sanctions freezing access to capital markets. Ratings agencies and the International Monetary Fund have warned that companies in the developing world may struggle to meet $180 billion of dollar debt borrowed before the energy crisis and that comes due in the next four years.

S&P has 30 emerging-market companies and countries with $85 billion of debt on its list of “potential fallen angels,” or issuers that are on negative watch with the lowest investment-grade rating, according to a report published last month. Brazilian and South African issuers, including Vale SA and Transnet SOC Ltd., account for about half of the total. In 2015, S&P’s global fallen-angel count reached 55, the highest since 2009, as Brazil’s export-driven economy stumbled and Russia remained isolated by sanctions.

State-owned companies whose governments are likely to suffer downgrades are most at risk of becoming fallen angels because their credit ratings will usually be linked to the sovereign’s, according to Joep Huntjens, a money manager at Netherlands-based NN Group NV, which had about $197 billion under management as of Dec. 31. A raft of Russian and Brazilian state-owned companies were pushed into junk along with the sovereign last year.

S&P Downgrades

S&P has distinguished itself among major ratings firms this year as quickest to respond to a 59 percent decline in crude prices in the past two years. In February it cut Saudi Arabia, Oman, Bahrain and Kazakhstan, citing “a marked and lasting impact” from oil’s downturn. S&P also delivered Poland’s first credit rating downgrade ever in January, citing concern that a new government will erode the independence of key institutions.

South Africa’s credit risk has climbed this month on concern it will lose at least one its investment-grade ratings. While Moody’s puts South Africa’s two levels above junk, 12 of 13 economists and analysts surveyed by Bloomberg forecast that S&P will cut its BBB- grade by the end of the year.

“A sovereign downgrade could lead to erosion of some corporate ratings,” said Singapore-based Huntjens. “We haven’t seen the end of the fallen angels trend yet.”

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