Why EM Corporate Debt Deserves a Place in Your Portfolio

03 September 2019

4 min read

Elizabeth Bakarich, CFA| Portfolio Manager—Emerging Market Corporate Debt

For years, when institutional investors talked about the makeup of their emerging-market (EM) bond portfolios, they were talking about currency. Some bonds would be denominated in US dollars, others in the local currency of the issuing country—Mexican pesos, for example, or Chinese renminbi. But nearly all were sovereign bonds.

EM corporate bonds have historically been relegated to the periphery of fixed-income portfolios—if they’re represented at all. There was $113 billion benchmarked to J.P. Morgan’s EM corporate indices as of June 30, about one-sixth of the amount tied to its hard- and local-currency sovereign indices.

This under-allocation may have been understandable a decade ago when the outstanding debt stock was lower and less diversified. It isn’t anymore. The total EM corporate debt stock doubled between 2012 and 2018 to $2.3 trillion, about twice the amount of outstanding hard-currency EM sovereign debt. And the standard EM corporate benchmark, the J.P. Morgan CEMBI, encompasses bonds from more than 600 corporate issuers in 52 different countries (Display 1).

A Bigger Pond to Fish In: EM Debt’s Growing Opportunity Set

Total Debt Stock (USD Trillions)

As of June 30, 2019
For informational purposes only. There can be no assurance that any investment objectives will be achieved.
Corporate Debt: J.P. Morgan CEMBI Broad Diversified; Local-Currency Sovereign: J.P. Morgan GBI-EM Global Diversified; Hard-Currency Sovereign: J.P. Morgan EMBI
Global Diversified
Source: J.P. Morgan Markets and AllianceBernstein (AB)

Widening the Opportunity Set

How investors add EM corporates to an existing fixed-income allocation will depend to some extent on their individual needs and comfort level. For institutional investors with dedicated EM mandates to hard- and local-currency sovereign bonds, it can be as easy as adding a stand-alone allocation to EM corporates.

An allocation to corporate debt provides diversification through exposure to more countries and to different parts of the credit cycle. It also gives investors access to a wider range of issuers in different sectors, often with a spread pickup over EM sovereign debt.

The Limits of a Sovereign-Only Allocation

Investors with discretionary mandates who entrust their allocation to a manager might benefit from a blended approach that adds corporates to the 50/50 mix of hard- and local-currency sovereign debt that most investors use today.

Again, diversification and downside protection are key. For example, a sharp rise in the US dollar—and a corresponding slide in EM currencies—hit local-currency sovereigns hard between 2013 and 2016 and wreaked havoc on traditional 50/50 blended strategies.

An allocation to hard-currency corporates would have diversified the currency risk in the 50/50 blend by giving investors exposure to companies with dollar-denominated export revenues. For these types of issuers, a rising dollar was good news because it boosted margins and cash flow.

In 2015, there was a 16.7% difference in annual returns for hard-currency corporates and local-currency sovereigns. Such disparities aren’t unusual.

High Quality—and Lower Volatility

Institutional investors with a lower risk tolerance might consider getting exposure to emerging-market debt (EMD) through an investment-grade only approach, split between sovereign and corporate debt. This is an increasingly popular strategy among insurance companies, pension funds and others who have traditionally focused on developed-market (DM) credit exposure.

Adding investment-grade EM corporates can give investors high quality with attractive yields. That’s because yields are higher than those on comparably rated debt from US companies—an important consideration at a time when low interest rates globally are making it harder than ever for investors to generate income.

And in recent years, the average credit quality of investment-grade EM corporate debt has converged with that of US investment-grade bonds. In fact, there’s never been such a small gap between the average ratings of the two sectors (Display 2).

Not Much Difference Between EM and US Corporate Credit Quality

Through May 31, 2019
Source: Bank of America Merrill Lynch and AllianceBernstein (AB)

Volatility for the asset class has also declined sharply in recent years (Display 3).

Smoother Ride: High-Quality EMD Has Become Less Volatile

As of December 31, 2018
Historical and current analyses do not guarantee future results.
Annualized volatility is shown for the J.P. Morgan EMBI Global-Investment, Grade, J.P. Morgan CEMBI Broad Investment Grade, and J.P. Morgan US Liquid (JULI)
Investment-Grade indices.
Source: Bloomberg Barclays and J.P. Morgan Markets

What to Look for in an Asset Manager

EM corporate bonds aren’t entirely without risk, of course. While corporate governance, transparency and protections for creditors and shareholders have improved over the last decade, they still lag standards in developed economies. This is why it’s so important to choose the right manager for your EMD allocation.

First, let’s tackle the issue of expertise. Investors or their advisors should make sure that prospective managers have a long track record of investing in all types of EMD assets and a thorough understanding of the risks associated with emerging market corporates—economic, political, credit and industry-related.

Equally important is having a team of dedicated EM analysts who focus exclusively on EM issuers and collaborate with industry specialists, who can add important perspective when determining the relative value of a credit.

Prospective managers that cut corners in the research process probably aren’t seeing the whole picture of the credits they’re investing in.

As wealth continues to shift from developed to emerging economies, growth across the emerging world is likely to accelerate, boosting the bottom lines of an increasingly dynamic set of EM companies. There are complexities associated with analyzing EM corporate credit. But we think the size and diversification benefits that EM corporates offer make them a valuable addition to any bond portfolio.

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.

About the Author

Elizabeth Bakarich, CFA

Elizabeth Bakarich is a Senior Vice President and Portfolio Manager, focusing on emerging-market corporate debt. She is a member of the Credit, Emerging Market Corporate Debt and Emerging Market Debt portfolio-management teams. Bakarich became part of the Emerging Markets team in 2014, working as an associate portfolio manager on corporate and local-currency debt portfolios. Prior to that, she worked in the firm's London office on the Global and European Credit teams. Bakarich joined the firm in 2006 as an associate with the US Municipal Group and later became supervisor of that group. She holds a BS and MS in mathematics from the Stevens Institute of Technology. Bakarich is a CFA charterholder. Location: New York

This information is for exclusive use of the wholesale person to whom it is provided and is not to be relied upon by any other person. It is not intended for retail or public use and may not be further distributed without prior written consent of ABAL.
This webpage has been prepared by AllianceBernstein Australia Limited (“ABAL”)—ABN 53 095 022 718, AFSL 230 698. Information in this webpage is only intended for persons that qualify as “wholesale clients,” as defined by the Financial Markets Conduct Act 2013’, and is not to be construed as advice. This webpage is provided solely for informational purposes and is not an offer to buy or sell securities. The information, forecasts and opinions set forth in this webpage have not been prepared for any recipient’s specific investment objectives, financial situation or particular needs. Neither this webpage nor the information contained in it are intended to take the place of professional advice.
You should not take action on specific issues based on the information contained in this webpage without first obtaining professional advice. Past performance does not guarantee future results. Projections, although based on current information, may not be realized. Information, forecasts and opinions can change without notice and ABAL does not guarantee the accuracy of the information at any particular time. Although care has been exercised in compiling the information contained in this webpage, ABAL does not warrant that this webpage is free from errors, inaccuracies or omissions. ABAL disclaims any liability for damage or loss arising from reliance upon any matter contained in this webpage except for statutory liability which cannot be excluded.
No reproduction of the materials on this webpage may be made without the express written permission of ABAL. This information is provided for persons in Australia only and is not being provided for the use of any person who is in any other country.