Money managers are diving into emerging markets corporate debt strategies as issuance of, and investor interest in, the securities are on the rise.
Only about $30 billion is run in these strategies now, with most of the money coming from non-U.S. investors. But managers say it's just a matter of time before investors catch on to this third subasset class within emerging markets debt (the other two being sovereign debt based in either U.S. dollars or local currencies).
“The amount of new issuance and new interest from investors (in dedicated emerging markets corporate strategies) is considerable,” said Nish Popat, senior investment manager at ING Investment Management, The Hague, Netherlands. “It is one of the fastest growing asset classes out there. In the first quarter of this year, we've had $90 billion in new issuance in the corporate space.” Mr. Popat said he expects the corporate market to grow “quite substantially” in coming years.
While emerging markets debt managers have included corporate bonds in broader debt strategies for some time, they're seeing a growing demand for a dedicated approach.
Firms that have rolled out new emerging markets corporate debt strategies in the past year or so include Aberdeen Asset Managers Ltd., ING, Insight Investment Management (Global) Ltd., Investec Asset Management Ltd., Morgan Stanley Investment Management and T. Rowe Price International Ltd.
Currently, investors are piling into local currency emerging markets sovereign debt (Pensions & Investments, Feb. 6), the largest of the emerging markets debt markets. Managers expect corporate strategies will follow a similar path, with larger, more sophisticated investors that want to control allocation among corporate and sovereign emerging markets debt leading the move.
“I see this as the next iteration in terms of participating in emerging markets growth,” said Colm McDonagh, head of emerging markets fixed income at Insight, London. Insight launched its corporate strategy in March and runs about $350 million.
Early movers already have glimpsed the growth their competitors are expecting. Assets under management at Ashmore Investment Management Ltd. and BlueBay Asset Management LLP, which launched their emerging markets corporate debt strategies in 2007 and 2008, respectively, have seen assets grow to $2.7 billion and $3.9 billion as of Dec. 31, respectively, according to data from eVestment Alliance, Marietta, Ga.
Pacific Investment Management Co. LLC, which launched its strategy in 2009, runs $2 billion in dedicated corporate emerging markets debt strategies and another $50 billion of emerging markets corporate bonds in other, broader strategies, according to data from PIMCO.
Managers say current depressed valuations make for a good entry point for investors, as does the fact that there's still an early mover advantage, in part from technical factors. “There is not enough (investment) in dedicated assets” to drive spread tightening like that seen in sovereign markets, said Anton Dombrovsky, vice president and product manager at PIMCO in Munich. “We have no doubt this is going to change.”
Issuance of new dollar-based bonds from emerging markets companies has outpaced that from governments since 2003, a trend that will only accelerate now that European banks have slashed their lending. Investors are “benefiting from the change in the financial system,” said Insight's Mr. McDonagh. “Now these companies have to come to capital markets to get their financing.”
But the new borrowing isn't a concern, said Max Wolman, portfolio manager at Aberdeen in London, “because they're not adding additional leverage; they're just refinancing.”
In fact, managers tout emerging markets companies' generally lower leverage, stronger balance sheets and lower default expectations vs. their developed markets cousins, while still delivering a greater yield. “You're taking a higher-octane exposure to U.S. dollar debt,” said PIMCO's Mr. Dombrovsky.
Investor interest in emerging markets corporate debt has been highest in Asia and Europe, where investors already have embraced sovereign strategies. “We've seen most of this interest outside of the United States,” said Peter Preisler, director and head of Europe, the Middle East and Africa at T. Rowe Price in Copenhagen.
Three-year track records “won't be so sacrosanct” in a burgeoning space like emerging markets corporate debt, Mr. McDonagh said.
“People are getting more and more comfortable in the emerging markets space,” said ING's Mr. Popat. As they gain familiarity with one part of emerging markets debt, they'll likely move on to others seeking broader diversification.
The next logical progression would then be local currency corporate debt, something managers say is coming but is still a few years off.
Although companies in some countries have begun issuing local currency bonds, “you don't tend to see the liquidity in the secondary market for those securities” because they're bought and held by local pension and sovereign wealth funds, said Robert Stewart, managing director and client portfolio manager for emerging markets debt at J.P. Morgan Asset Management, London. “In three to five years' time, I would expect to see enough demand and liquidity for there to be an established market for local-currency corporate debt.”
T. Rowe Price's Mr. Preisler said that market “will develop slowly, but surely.”
However, others aren't convinced investors will be drawn to local currency corporate debt. Aberdeen's Mr. Wolman said that while hard-currency bonds are issued under U.S. or U.K. law, local currency bonds follow local laws. Therefore, defaults in local currencies “could get quite messy,” and the legal issue adds another layer of uncertainty to the investment.
Polina Kurdyavko, partner and senior portfolio manager at BlueBay in London, added in an e-mail that “withholding tax, (foreign exchange) controls, access to custody accounts and the legal and regulatory framework for corporate issuance are all significant issues yet to be overcome” before BlueBay would want to launch an emerging markets local currency corporate debt strategy.