Cushion Rate Increases with EM High Yield
September 02, 2022
Read Time 3 MIN
Since the beginning of 2022, emerging markets fixed-income investors have experienced negative returns as interest rates and credit spreads both moved higher due to several macro factors such as rate hikes, weaker local currencies, and downward GDP growth revisions. Despite the stiff headwinds, certain mitigating factors may make emerging markets corporates relatively resilient going forward.
First, emerging markets high yield USD bonds can offer higher yields without direct local currency risk. The higher yield provides a significant cushion against rising U.S. interest rates and the impact of potentially wider spreads if recessionary risks grow. As shown in the chart below, at the end of July, emerging markets high yield corporate USD bonds, represented by the ICE BofA Diversified High Yield US Emerging Markets Corporate Plus Index (the “Index”), yielded 11.3%, the highest among major fixed income asset classes and 3.5% higher than U.S. high yield bonds. The spread was 853 bps, higher than the 10-year average of 612 bps. Excluding China’s real estate sector, the yield (9.53% vs a 10-year average of 7.60%) and spread (679 bps) on the asset class are still at historically attractive levels in absolute terms and relative to U.S. high yield. New issuance of emerging markets corporate debt has been extremely low during the first eight months of the year, providing additional technical support. Net issuance (excluding coupons) among emerging markets corporates year-to-date is negative at -$63 billion, more than offsetting fund outflows.1
Source: ICE Data Indices, LLC and J.P. Morgan as of 7/31/2022. EM High Yield Corp: ICE BofA Diversified High Yield US Emerging Markets Corporate Plus Index; Local Currency EM Sovereign: J.P. Morgan GBI-EM Global Diversified; USD EM Sovereign: J.P. Morgan EMBI Global Diversified; U.S. High Yield Corp: ICE BofA U.S. High Yield Index; US IG Corp: ICE BofA Corporate Bonds Index; US Agg: ICE BofA US Broad Market Index; Global Agg: ICE BofA Global Broad Market Index. Yield to Worst measures the lowest of either yield-to-maturity or yield-to-call date on every possible call date. See important disclosures and index definitions at the end of the presentation. ICE BofA composite ratings are simple averages of various ratings, and are not intended to be a credit opinion. Past performance is no guarantee of future results.
Emerging markets corporates still have relatively strong fundamentals to cushion the impact of the headwinds. A strong Q1 earnings result shows emerging markets corporates had 25% EBITDA growth year-on-year2, excluding China’s real estate sector, while leverage was stable. Not surprisingly, companies in commodity-related businesses had better results than other sectors. The high yield default rate3 has increased to 8.1% so far this year, significantly higher than the historical average and the rate for U.S. high yield. But much of the default story has made its way through the index, as China Real Estate and Russian corporates combined represent more than 90% of the default volumes. At the end of July, the Index held 9.6% Chinese corporate bonds, 3.6% of which are in the real estate sector. The Index has not held any Russian bonds since the end of March.
Emerging markets commodity-related businesses have benefitted from the commodity boom in the first half of 2022. The Index has approximately 35% allocation to bonds issued by commodity-related4 companies. Commodity prices have come down during the summer but the global supply-demand picture for commodities remains very supportive.
Some emerging markets gain exporting competitiveness due to a strong dollar, lifting local business activities. Emerging markets countries with depreciating currencies have increased exports this year5, which helps local economies in general through increasing business activities and corporate earnings. The Index has close to 40% of its holdings allocated to exporting economies6, such as China, Mexico, Brazil, South Africa and Indonesia. China’s exports posted robust growth in July and jumped 18% in dollar terms from a year ago.7
China has shown a slow recovery after the government took a series of steps to restore the economy early this year and more recently loosened up the COVID restrictions. Although the looming risk within the property sector still exists, China’s recent accommodative policies are supportive of its economy in the near term and could provide a boost to other emerging markets economies as well. The Index has about 10% allocation to China and less than 3.75% in the real estate sector. However, the recent tension between China and Taiwan has heightened global geopolitical risk.
1 Source: J.P. Morgan as of August 11, 2022.
2 As of March 31, 2022. Source: J.P. Morgan Research, EM corporate earnings.
3 As of July 31, 2022. Source: J.P. Morgan Research, EM high yield default rates.
4 Commodity-related business includes ICE index sub-industry categories of energy, metals and mining, steel, chemicals, capital goods and building materials, etc.
5 Source: United Nation. Global Trade Update, July 2022.
6 Exporting economies include both large EM exporting countries and export-dependent EM countries. Large exporting countries are the top 25 exporting countries in the world based on 2020 international trade data according to the United Nation. Export-dependent countries are countries with exports of goods and services over 60 percent of GDP based on 2020 international trade data according to the World Bank.
7 As of August 7, 2022. The Wall Street Journal.
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The views and opinions expressed are those of the author(s) and are current as of the blog’s posting date, and are not necessarily those of VanEck or its employees. Blog commentaries are general in nature and should not be construed as investment advice. References to specific securities and their issuers or sectors are for illustrative purposes only. This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities/financial instruments mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. ICE BofAML Diversified High Yield US Emerging Markets Corporate Plus Index (EMLH) is a U.S. dollar-denominated bonds issued by non-sovereign emerging markets issuers that are rated below investment grade and issued in the major domestic or eurobond markets. In order to qualify for inclusion in the Index, an issuer must have risk exposure to countries other than members of the FX G109, all Western European countries and territories of the U.S. and Western European countries.
The ICE BofAML Diversified High Yield US Emerging Markets Corporate Plus Index, formerly known as BofA Merrill Lynch Diversified High Yield US Emerging Markets Corporate Plus Index prior to 10/23/2017.
ICE BofA High Grade US Emerging Markets Liquid Corporate Plus Index tracks the performance of investment grade U.S. dollar denominated emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets.
ICE BofA US Broad Market Index tracks the performance of US dollar denominated investment grade debt publicly issued in the US domestic market, including US Treasury, quasi-government, corporate, securitized and collateralized securities.
ICE BofA Global Broad Market Index tracks the performance of investment grade debt publicly issued in the major domestic and Eurobond markets, including sovereign, quasi-government, corporate, securitized and collateralized securities.
ICE BofA US Corporate Investment Grade Index: tracks the performance of US dollar denominated investment grade rated corporate debt publicly issued in the US domestic market.
ICE BofA US High Yield Index: tracks the performance of U.S. dollar-denominated below investment grade corporate debt publicly issued in the U.S. domestic market. Qualifying securities must have a below investment grade rating. Original issue zero coupon bonds, 144a securities, both with and without registration rights, and pay-in-kind securities, including toggle notes, qualify for inclusion.
J.P. Morgan EMBI Global Diversified Index: tracks USD-denominated emerging markets sovereign bonds. The weighting scheme provides additional diversification by more evenly distributing weights among the countries in the index.
J.P. Morgan GBI-EM Global Diversified Index: bonds issued by emerging market governments and denominated in the local currency of the issuer. The weighting scheme provides additional diversification by more evenly distributing weights among the countries in the index.
Emerging Market securities are subject to greater risks than U.S. domestic investments. These additional risks may include exchange rate fluctuations and exchange controls; less publicly available information; more volatile or less liquid securities markets; and the possibility of arbitrary action by foreign governments, or political, economic or social instability.
There are inherent risks with fixed income investing. These risks may include interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond. When interest rates rise, bond prices fall. This risk is heightened with investments in longer duration fixed-income securities and during periods when prevailing interest rates are low or negative.
All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future performance.
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