Why emerging market corporate debt should be in every bond portfolio

Sustainably higher rates of return in combination with, in historic terms, lower default risks – this is the profile that corporate bonds from emerging economies offer in contrast to the bonds of European and US firms. Corporate bonds denominated in US dollars should therefore be a strategic component of any bond portfolio. Within the increasingly mature and growing bond markets of emerging markets, the corporate bond sector offers investors additional diversification options and in many cases great investment opportunities with a higher earnings potential.

Corporate bonds from emerging economies outperform US securities

Between 2004 and 2016, the JP Morgan Corporate Emerging Markets Bond Broad index outperformed a comparably balanced portfolio of US corporate bonds in eight out of 13 years. Above all, the cumulative return of the securities from emerging economies was 10 percentage points higher at 130 per cent during this time period.

The yield pick-up is also in evidence when looking at the yield-to-worst (YTW) ratio, which traces the lowest potential yield investors can receive from a given bond – without the issuer defaulting. For EM corporate bonds, this ratio stood at 4.4 per cent by the end of February 2017, compared to a score of 3.28 per cent for securities from US companies. If you limit yourself to the high yield sector, you will find that EM companies promised a rate of return at this point that topped US equivalents by 58 basis points (6.22 percent versus 5.64 percent). The potential yield advantage that securities from emerging economies show remains in place even if you adjust to allow for ratings.

Lower debt ratios bringing down the number of defaults

Another reason speaking in favour of a permanently upgraded weighting of corporate bonds from emerging economies is the low debt level characterising many conglomerates based in emerging markets. Specifically, the net debt-to-equity ratio of all rated US groups was around 32 per cent higher on average by mid-2016 than comparable companies from emerging economies. This is one of the downstream factors also responsible for the low default rates of corporate bonds from emerging economies. Based on data released by Standard & Poor’s, the rates undercut those of US corporate bonds in 15 out of the 17 years since the year 2000. Over the same period of time, EM groups also undercut their European competitors in 10 of the 17 years.

Robert Schmieder is Senior corporate analyst at VanEck