Entry points for emerging markets Entry points for emerging markets https://stage-fii.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png https://stage-fii.federatedinvestors.com/daf\images\insights\article\global-connectivity-small.jpg May 27 2020 May 27 2020

Entry points for emerging markets

Attractive valuations exist across IG and high-yield credit segments.
Published May 27 2020
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Recent market dislocation arising out of the Covid-19 pandemic could provide an entry point for long-term emerging-market (EM) investors. Although it’s difficult to time a market bottom while the world faces widespread economic downturn and potential further volatility, we take a constructive view.

The emerging markets fixed-income space is offering attractive valuations. The spreads between yields on EM corporate and sovereign debt and comparable-maturity U.S. Treasuries are near 2008-09’s financial crisis levels. These attractive valuations exist across both the investment-grade and high-yield credit segments of emerging markets. We are confident a calculated exposure across both segments should outperform once the pandemic recedes and market volatility subsides.

We expect normalization in this asset class to center on the investment-grade spectrum. Supported by unprecedented levels of developed-market monetary stimulus, EM sovereign issuance has risen sharply over the past month, especially investment grade. With robust balance sheets, strong liquidity and cash flow generation, investment-grade corporates should follow in their wake. In particular, we think Latin American high-quality corporate bonds in the food commodity sectors are positioned to benefit from a potential recovery in China that should ultimately spread to the developed world. In spite of oil’s dramatic collapse, we also see opportunities in some Russian corporates, high-grade oil exporters and certain quasi-sovereign issuers. On the sovereign side, issuers such as Abu Dhabi, Qatar and Saudi Arabia enjoy significant currency reserves, large net foreign asset positions, low debt levels and a low cost of producing oil.

On the high-yield front, the picture is more nuanced, with a bifurcation between BB-rated credits that should trade up with their investment-grade counterparts and lower rated high-yield credits trading at or near recovery values. We think their valuations have overshot the longer-term fundamental reality. This wide array of options within the high-yield complex should provide investors with selective opportunities alongside high-quality positions.

Much has been made of the impact the recent G-20 sponsored debt relief initiative for low-income counties on the EM high-yield space. We are reassured by the public statements from a number of African and South Asian issuers that bonds will not be drawn into such a process. The eurobond market remains an important funding source to high-yield issuers, and policymakers would be loathed to lose it as this channel provides attractively priced instruments with much longer tenors than traditional pools of debt. We like reform-minded issuers such as Ukraine, supported by the International Money Fund. Over the last two years, Ukraine has made structural fiscal adjustments, implemented a land-reform package and set anti-corruption measures. Latin American corporates are poised to benefit due to their strong balance sheets and business models that benefit from the stimulus being provided in developed markets and emerging Asia. Distressed situations such as Ecuador and Argentina potentially have upside from their significant distressed levels.

We remain cautious on Turkey as the country faces acute external vulnerabilities stemming from a sharp drop in international reserves, tourism and exports, and a stubbornly high import bill. Lastly, the Mexican government’s response to the pandemic remains underwhelming, consistent with its problems in oil-production discussions, domestic economic policy and communications with the international investment community.

While EM debt assets could exhibit volatility in the shorter-term, our overriding view is for positive returns over the medium to long term.

Tags International/Global . Fixed Income . Coronavirus .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Credit ratings of A or better are considered to be high credit quality; credit ratings of BBB are good credit quality and the lowest category of investment grade; credit ratings BB and below are lower-rated securities ("junk bonds"); and credit ratings of CCC or below have high default risk.

High-yield, lower-rated securities generally entail greater market, credit, and liquidity risk than investment-grade securities and may include higher volatility and higher risk of default.

International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards. Prices of emerging-market and frontier-market securities can be significantly more volatile than the prices of securities in developed countries, and currency risk and political risks are accentuated in emerging markets.

Federated Investment Management Company

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