What are the attractions of emerging market corporate bonds and what are their benefits in a rising interest rate environment?
For investors with a medium to long-term outlook, globally diversified emerging market (EM) corporate bonds have a clear advantage over developed markets. Emerging market bonds not only offer investors significantly higher yields (interest income), but also come with a shorter duration, which is attractive in today’s rising interest rate environment.
Three major advantages:
- Higher risk-adjusted return, lower correlation to other asset classes – Emerging market corporate bonds offer higher yields due to higher “perceived” risks. However, for deep fundamental-oriented active managers with disciplined portfolio construction and risk management approaches, this asset class could offer significant alpha.
- Shorter duration – particularly attractive amid current expectations of rapidly rising US interest rates.
- Benefits of diversification – both on the asset side (better selection of bonds) and on the liability side (less client redemption shock). Emerging market companies offer a diversified investment universe, with attractive companies in various industries from different countries, which helps to diversify risk. The correlation between each leg of the portfolio is low, especially for high yield credits. Global Emerging Markets portfolios also benefit from a diverse global client base, which helps avoid the shock of simultaneous redemptions in the same region, as we have seen in Asia in recent years.
Which sectors and countries offer the best opportunities, and where is the strategy allocated on the credit rating and duration spectra?
First, we highlight that truly global emerging portfolios diversified, in terms of sector and country allocation, offer more attractive risk-adjusted returns than Asia-focused portfolios with inherently higher volatility and cyclicality, particularly across market cycles. Regionally, we believe that Latin America harbors attractive opportunities, including selective companies in countries such as Brazil, Chile, Colombia and Mexico. We see 2022 as a year for commodity producing sectors/regions, supported by soaring commodity prices.
We also see the value of oversold bonds in China’s real estate sector, as well as Chinese rates/politically sensitive credits, such as Tier 2 bank bonds and collateralized bonds issued by local government finance vehicles. Chinese (LGFV). Once the supportive policies are implemented, these bonds have the potential to outperform in 2022. Companies related to industrial production and fixed investments could also benefit from fiscal stimulus measures, which would cause their bonds to perform well.
Currently, we are focusing on short duration HY bonds, as well as some longer dated bonds with the belief of spread tightening, to weather the current market turmoil.
What are the expected returns and what are the biggest risks for the strategy?
The divergent inflationary outlook between China and the United States, combined with volatile commodity prices, geopolitical tensions in Asia-Pacific and Europe (particularly after Russia’s invasion of Ukraine) and Persistent supply chain challenges are the main risks we face this year and investors should expect much more. market volatility than in previous years.
We believe volatility will be the name of the game in 2022 and credit selection will be key. Consequently, it has become increasingly important for investors to diversify their allocation across global markets versus a portfolio concentrated in Asia. In a year where benchmark beta returns can be disappointing, we believe an active approach will be essential for investors to generate incremental returns.
the Asia Fund Selector Hong Kong Investment Forum was held virtually on March 8, 2022 and was sponsored by HSBC Asset Management, Jupiter Asset management, Nuveen and Vontobel Asset Management.
Learn more about what was discussed and the strategies that were presented here: https://fundselectorasia.com/events/fsa-investment-hong-kong/