Emerging-Markets Corporate Debt

Six Secrets of Successful Research

16 May 2018

4 min read

Okan Akin, CFA| Research Analyst—Corporate Credit

Emerging-Markets Corporates (EMC) are full of dynamism and opportunity—but come with some specific risks attached. How can skilful research help EMC investors capture these higher-yielding opportunities while avoiding the pitfalls?

Know who you are dealing with

Assessing a bond depends crucially on two related factors: the borrowers’ ability and willingness to pay. In EMC, you will find a wide spectrum of willingness to pay, with differing governance cultures. For instance, in some EM countries there is no stigma attached to repudiating a debt. While this cultural feature is not a definitive reason to avoid these countries’ bonds, it’s certainly a red flag when business conditions start to deteriorate (e.g. equity values fall) and ability to pay becomes strained. Absolute rulers and their associates may also have a less stringent attitude to governance than a developed-world investor might expect. Knowing the history of powerful families and how they deal with bondholders should be an important component of your analysis. Experienced EMC analysts will build up a blacklist of untrustworthy issuers and their controlling entities.
Talk to the right people

In EMC, many investors are guided by the reputation of leading companies and their controlling families. But the PR façade can often be deceptive. You need to look deeper and find sources of information with local insights. Over time, skilled analysts can build a trusted network of journalists, local banks and business people. Those sources can help look behind the façade and spot the risks and opportunities that others may miss.
Don’t be scared by headline risk

Some of the headlines and video footage of protests and scandals in an EM country can be disturbing. But remember, sensationalism is one of the features of a free press. It often goes together with desirable features like an independent judiciary, respect for good governance and robust institutions that can hold powerful individuals to account. What’s more, vigorous press coverage can lead to positive outcomes in terms of improved political and corporate governance. Recent reforms in Brazil, and the start of more shareholder-friendly behavior by some leading South Korean chaebols, are cases in point. So, it’s important to discern the underlying picture behind the headlines, and to remember that the hidden problem areas for investors are more likely to be in countries where the lawmakers suppress investigative journalism.
Look at the big picture

If you want to get to the bottom of an EMC issuer’s finances, you need to bear in mind some special features of the EM world. It’s easy to imagine that scrutinizing the financials of an individual company will provide reliable insight into its credit status.

But not so fast. In EM, many companies are part of diversified industrial/commercial conglomerates. These feature multiple layers of companies, each with their own balance sheet and debt exposures.

Don’t make an expensive mistake by looking just at the individual issuing entity. You need to zoom out and examine the big picture, including all the entities that might be adding to the debt burden. Many investment managers organize their EMC research on discrete industry lines, rather than on a cross-industry basis. In our experience, that’s a sure way to lose money in EMC.
Have conviction

To make real money in EMC, you need to do thorough research and back it with well-judged risk-taking.

Skilled research into EMC can often identify situations where investors have panicked and lost confidence, but where the bond issues in fact have good credit status. And by buying into bonds trading at distressed prices, resolute investors can win big paydays when these bonds are later rerated closer to par. There are many reasons why the market may misjudge an EMC bond. For instance, inexperienced investors may overlook the factors that will ultimately make a government or a powerful sponsor refuse to let an indebted company fail. But with insight and conviction, investors can buy into these apparently distressed situations.
Make sure the story is consistent

In the world of fixed-income research generally, there is no substitute for rigorous research and precise analysis of future cash flows. But in EMC you really need to read the footnotes to the accounts and above all to make sure that the issuers’ information is consistent year on year. A skilled EMC analyst will keep asking issuers’ management the same questions about their strategy, operations and financing, to make sure she keeps hearing the same replies. An unexpected change of story can be the red flag that highlights a potential problem.

The Proof of the Performance Pudding

In EMC, index tracking funds typically underperform the benchmark, as it is hard to replicate the universe of opportunities successfully. Active manager success versus the benchmark varies over time (Display, left). However, skilled active managers can add significant value versus the benchmark, gross of fees (Display, right). Skilled research—and the resulting successful credit selection—can make a big difference in this asset class, in our view.

Skill Matters in Emerging-Market Corporates

As of March 31, 2018
Past performance is no guarantee of future results.
These performance numbers are before the deduction of manager fees. They demonstrate manager skill rather than net value added for investors.
Benchmark is the J.P. Morgan CEMBI Broad Diversified Index. Based on the eVestment universe of Global Emerging Markets Corporate Bond managers including strictly USD-based managers.
Source: eVestment

But of course, these numbers just show an overall universe snapshot. Even within the outperforming managers, the return dispersion was wide over the last five years, averaging around a 14% gap between highest and lowest. So you need to choose your manager carefully to get the best performance outcome.

In EMC, there is no substitute for experience, effort and rigorous analysis. Investors should embrace the attractions of EMC but do their research carefully.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams and are subject to revision over time. AllianceBernstein Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom.

About the Author

Okan Akin, CFA

Okan Akin is a Senior Vice President and Corporate Credit Research Analyst, focusing on emerging-market issuers. Prior to joining AB in 2012, he was a director in the Global Markets and Strategy Group at Royal Bank of Scotland, where he was responsible for credit strategy for Central and Eastern Europe, the Middle East, and Africa. Prior to that, Akin was a director in the Emerging Markets Fixed Income Research Group at J.P. Morgan, where he initiated coverage of the Middle East. He holds a BA in business administration and international relations from Bosphorus University, Istanbul, and an MS in European economics and policy from the London School of Economics and Political Science. Akin is a CFA charterholder. Location: London

This is a marketing communication. This information is provided by AllianceBernstein Limited, 60 London Wall, London, EC2M 5SJ. Registered in England, No. 2551144. AllianceBernstein Limited is authorised and regulated in the UK by the Financial Conduct Authority (FCA - Reference Number 147956). It is provided for informational purposes only and does not constitute investment advice or an invitation to purchase any security or other investment. The views and opinions expressed are based on our internal forecasts and should not be relied upon as an indication of future market performance. The value of investments in any of the Funds can go down as well as up and investors may not get back the full amount invested. Past performance does not guarantee future results. This information is directed at Professional Clients only and is not intended for public use.

Emerging-Markets Corporate Debt

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