Emerging markets corporate debt is presenting money managers with a dilemma: an expected net-negative supply of hard currency paper this year is driving an improved technical picture, but at the same time there are liquidity concerns around the low issuance.
Sources said issuance of corporate debt by companies in the emerging markets is set to fall in 2016 following a few soft years, as geopolitics and other factors continue to weigh on the asset class.
“Our view is we are going to have negative net supply this year — we expect $200 billion of issuance — and that is not enough bonds to go round, just to satisfy coupons and redemptions,” said Steve Drew, head of emerging market credit at Henderson Global Investors Ltd., in London.
Rodica Glavan, London-based portfolio manager, emerging markets, at Insight Investment, said gross issuance of an estimated $240 billion for this year will be eaten up by amortizations and coupons of about $200 billion, giving net financing needs of about $40 billion. That compares with $210 billion two years ago. On top of that, emerging market corporations continue to manage their liabilities in the form of buybacks or early calls on their bonds. If that follows the same pace as in 2015, at about $50 billion, “then net financing will be negative for the year,” she said.
And this is taking place as three years of bearish behavior from money managers and their institutional investor clients turns a corner.
The latest figures from data provider eVestment LLC show that institutional investors pulled $18.8 billion from emerging markets fixed-income strategies in the three months ended Dec. 31. Three years previous, investors piled $22.1 billion into the strategies during the comparable quarter in 2012. However, money managers said investors are returning to the markets, particularly over the past few weeks as emerging markets corporate debt has rallied. The BofA Merrill Lynch U.S. Emerging Markets External Debt Sovereign & Corporate Plus index gained 3% in March, and is up 4.4% so far this year. That compares with 1.1% for all of 2015.
The lower issuance is a result of a number of factors. Mr. Drew said ongoing Russia sanctions will remove about 7% of emerging markets corporate paper. Sources doubt that Brazilian companies — with the country in the midst of a political storm — will issue this year, accounting for a further 7% of corporate paper disappearing from the market. Oil and commodity-related companies will be affected if oil prices stay lower for longer.
“You can easily come up with another probably 10% to 15% of the market that will not be able to issue,” Mr. Drew said. “That makes, effectively, more than one-third of the market that won't issue this year.”
And China, which had been a serious player in the emerging markets corporate bond space, has withdrawn somewhat. “The China onshore market has grown substantially — we are seeing the Chinese government encouraging corporates to come to the onshore rather than offshore market (for finance),” said Nish Popat, London-based manager in Neuberger Berman's emerging markets corporate debt team. “That has had a dramatic effect on supply from China, which has been a major issuer of offshore bonds the last three years.”
Lower issuance moves investors into a “paradoxical world,” said Pierre-Yves Bareau, emerging markets debt chief investment officer at J.P. Morgan Asset Management in London. He said it is good news in the near term, bringing a “renewed appetite for emerging markets ... and creates a bit more upside from where we are now. We are probably more comfortable on corporates at this stage than we could have been,” he said. But in the longer term, continued net negative supply could put pressure on investors looking to reinvest future maturities.
Other executives agreed that there is a positive angle to lower issuance. Ms. Glavan said net negative financing “only adds to our positive view on emerging markets corporates, as it bolsters the technical position of the asset class.”
“Ultimately this is a positive environment for spreads, in the sense that reduced supply helps rebalance the market and can ultimately help support valuations,” said Bryan Carter, London-based head of emerging market fixed income at BNP Paribas Investment Partners. “It's also positive to the degree that corporates reduce leverage, at the margin, by taking less debt provided they are not under distress or going elsewhere for that funding under less favorable conditions.”
And Sergio Trigo Paz, managing director, head of emerging markets fixed income at BlackRock Inc., based in London, also said he views the issuance situation as a positive. “Negative net supply means that there is not going to be a risk of oversupply immediately, the kind that could dampen the rally of the market. It is starting to put the brakes on price increases because several issuers were rushing to issue bonds first. Being negative (supply) mean investors have more coupons and redemptions to reinvest, or have a constant cash buffer — either to address volatility or to go into new issues,” he said.
But the difficulties that lower issuance brings are not lost on money manager executives. While net negative supply has contributed to “the most positive technical view that we have had for many years ... (lower issuance) makes life quite difficult as we have less bonds coming to the market — we would like more issuance actually, we would like issuance to be strong to keep the market in equilibrium,” said Siddhartha Dahiya, head of emerging market corporate debt in London at Aberdeen Asset Management. “If there is less issuance, the market can get a little detached from the fundamentals, can rally too much, which is not healthy for us.”