The Case for Emerging Market Corporates - IndexUniverse.com

Over the last decade, emerging market (EM) economies
have benefited greatly from macroeconomic
stabilization and the liberalization of trade and
financial markets. Most of these countries have enjoyed
robust gross domestic product (GDP) growth both on an
absolute basis and relative to more developed economies.
As a result, they have experienced dramatic economic
transformations and accelerated public sector deleveraging.
Gradually, local regulators have improved bankruptcy
regimes, market transparency and investor rights. This
has resulted in higher levels of foreign direct investment
and capital markets activity, which has greatly benefited
the growth of local corporations.
Given this positive macro backdrop, improved legal
environment and supportive demographics, companies
from many of these EM countries have been able to
increase their access to the international markets for both
debt and equity, broaden their investor base and extend
their maturity profiles. In several instances, EM corporates
have grown into global leaders in their respective sectors.
Since early 2000, EM corporate debt has evolved from
a marginal market with $20 billion in annual issuance
volume (mostly from Latin American issuers) to a global
market with average annual issuance in excess of $100
billion with representation from all four major regions
(Asia, Latin America, Central and Eastern Europe, and
the Middle East/Africa). 1 EM corporate fixed income has
effectively become an asset class in its own right, with
projections that outstanding corporate debt will exceed
$1 trillion in the next several years.
As valuations for EM external sovereign debt reach alltime
highs, fueled by record inflows and reduced sovereign
issuance, traditional EM investors are selectively increasing
their allocations to EM corporate debt. Furthermore,
global high-yield and investment-grade fixed-income
investors—or “crossover” investors—are also becoming
more actively involved in the asset class. An additional catalyst
to interest in the sector is the recent development of
the Corporate Emerging Markets Bond Index, 2 or CEMBI,
for external hard-currency debt obligations. Today there
are approximately $10 billion in assets under management
benchmarked against various CEMBI indexes, with expectations
that this will double by the end of 2011.
We believe that an allocation to EM corporate debt
could be an attractive option for investors seeking an
opportunity to diversify away from other traditional
fixed-income asset classes and add potential excess riskadjusted
returns. In most instances, EM corporate debt
investments still offer a positive basis over both sovereign
benchmark bonds and comparable developed-market
high-yield and investment-grade corporate fixedincome
securities—which is particularly compelling in
the current low-interest-rate U.S. Treasury environment.
When comparing potential returns—taking into account
historical default levels of high-yield EM corporates versus
those of U.S. high-yield indexes—the argument for
allocating assets to EM corporates becomes, in our view,
even more compelling.
An Asset Class Emerges
The performance of emerging economies over the past
decade has been notable, both on an absolute basis and relative
to developed markets. Given both prudent economic
policies and supportive external conditions, EM economic
growth has been strong and remained positive throughout
the global recession of 2008-09 (Figure 1). Today the underlying
macroeconomic fundamentals of emerging markets
are, in many instances, superior to those of the developed
world—most emerging economies have lower debt levels,
healthier fiscal balances and stronger debt positions than
their developed counterparts (Figure 2).
Developing governments have also made significant
progress in other areas, such as strengthening property
rights, reinforcing legal frameworks and improving creditor
rights. This has resulted in greater investment flows,
burgeoning local equity markets and increasing international
capital-raising activity. Foreign direct investment
flows to emerging markets, for example, have grown
steadily from $139 billion in 1997 to a projected $251 billion
for 2011. 3
EM countries are also further diversifying their sources
of economic growth by gradually shifting their export
bases from developed countries to more intra-EM trade.
Intra-EM exports grew from less than $24 billion in 1999
to nearly $37 billion in 2009; at the same time, exports to
developed economies fell from nearly $74 billion in 1999
to less than $61 billion in 2009. 4
EM countries have further enjoyed more attractive
demographic trends (population growth, emergence of
middle-class consumers 5 ) and larger labor forces, which
will continue to drive domestic demand and economic
output. These new markets provide an important source
of diversification that continues to support emerging market
growth in spite of weak external demand. Geographic
and product diversification has reduced contagion risks
through lower exposures to one particular region or mar-
Figure 1
10%
8%
6%
4%
2%
0%
-2%
-4%
Emerging Market Growth Exceeds
Developed Market Growth*
‘99 ‘00 ‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08 ‘09E ‘10F ‘11F
N Developed
N Emerging Markets
* Weighted average of 40 emerging economies.
Forecasts/estimates are based on current market conditions, subject to
change, and may not necessarily come to pass.
Source: MSIM, Official Source. Data as of August 2010.
www.journalofindexes.com September / October 2011
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