The Corporate Edge in Emerging Markets
Why do so many investors restrict their emerging-market bond investments to sovereigns? The corporate bond universe has grown dramatically in recent years—and offers a terrific combination of higher credit quality, wider spreads and potential capital gains.
Investor interest in emerging-market debt has grown significantly in recent years, for good reason. Emerging countries offer robust economic growth, rising per capita incomes and smaller government debt burdens than most of the developed world.
But why stick to sovereign bonds, as so many investors do? My colleague Shamaila Khan suggests that corporate bonds can be an even better way to gain exposure to emerging markets.
One simple exercise we did at the end of February this year was to compare the leading emerging-market corporate benchmark (the J.P. Morgan CEMBI Broad Diversified) and the leading emerging-market sovereign benchmark (the J.P. Morgan EMBI Global Diversified).
The first thing to note is that the credit quality of the corporate index was higher (Display): 71% of the debt in the corporate index was issued by investment-grade companies, while only 63% of the debt in the sovereign index was issued by investment-grade countries. 90% of the companies in the corporate index are located within investment-grade countries. As a result, the average quality of the corporate index is BBB, compared with BBB– for the sovereigns.
Yet, despite its higher quality, the corporate index paid investors slightly more than the sovereign index: At the end of February it was yielding 5.5% compared with the sovereign benchmark’s yield of 5.4%. Versus comparable US Treasuries, the corporate index provided a yield pickup of almost 4% for corporates, the sovereign index about 3.5%.
The corporate index also carried significantly less interest-rate risk than the sovereign index, as measured by an average duration of 5.2 years compared to 7.2 years for the sovereign index.
This index-level comparison illustrates a principle that applies to individual bond selection: If an investor wants exposure to a given country, it may make sense to express that view by selecting attractive corporate bonds within that country, rather than buying the government’s bonds. The added advantage of this approach is potential capital gains if the corporate outperforms its sovereign (we’ll come back to this in a future blog). Of course, this needs to be done in the context of a well-diversified portfolio that manages both sovereign and corporate risk.
A decade ago, investors had little choice but to invest in emerging-market sovereigns. That’s no longer true. The stock of hard-currency emerging-market corporate debt outstanding has grown by 250% since 2005, while the stock of sovereign debt has risen by only about 50%. We think this is going to continue to be an exciting growth area for years to come.
For added perspective on this topic, see “EM corporate bonds see as a better bet” in FT.com and “AllianceBernsteins Argues for Emerging Market Corporate Bonds” in barrons.com.
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The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Douglas J. Peebles is Chief Investment Officer and Head of Fixed Income and Shamaila Khan is a Portfolio Manager of Global Credit, both at AllianceBernstein.