A Value Opportunity In EM HY Corporate Bonds?

Aug. 02, 2018 7:25 AM ETEEM, VWO, EMB, IEMG, EDC, PCY, EDF, SCHE, EDZ, EDI, TEI, EMLC, EDD, VWOB, EMD, ELD, EMF, MSD, MSF, ADRE, EEV, EUM, EET, SPEM, LEMB, EBND, EMAG, XSOE, DBEM, FEM, HEEM, EMSH, EWEM, ROAM, ESGE, EDBI, EMLB, DIEM, KALL, EMTL, FEMB, RFEM, ESEB, EMBU, EMBH, IGEM, JEMD, EMEM, MFEM, PPEM-OLD, HYEM
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Emerging markets high yield corporate bond yields have widened significantly over the second quarter of the year and provide a yield pickup over U.S. high yield of 1.1% (as of July 20, 2018). On a spread basis, the pickup is more attractive at 117 basis points. The spread advantage reflects the comparatively lower duration of emerging markets high yield, which has an effective duration of 3.7, or approximately 0.4 lower than U.S. high yield. But does this yield and spread advantage represent increased value in the asset class?

Emerging markets high yield corporate bonds have historically provided a yield advantage over their U.S. counterparts, though the relationship has inverted several times historically. The real and perceived additional risks associated with emerging markets, including political and liquidity risks, have generally led investors to demand a higher yield from an emerging market corporate bond versus a U.S. one, assuming all else equal (e.g., same industry and credit rating).

Ratings agencies also tend to demand more favorable metrics before giving an emerging markets issuer the rating it might receive were it domiciled in a developed market. In fact, the emerging markets high yield corporate index carries a BB- average credit rating, whereas its U.S. counterpart carries a B+ average.1 Despite a higher hurdle with ratings agencies, the emerging markets index still achieves a higher average rating to complement its higher yield and lower duration.

So does the recent selloff present a value opportunity for emerging markets high yield corporate bond investors? We believe it does, given the supportive fundamentals and lower credit and interest rate risk in the asset class. Emerging markets growth still provides a favorable backdrop both outright and relative to developed markets, although the repercussions of a trade war may pose a threat to this dynamic.

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