Fixed income investors battle on through the pressure cooker bonds environment – and despite average yields of 4% meaning that high-yield is no longer ‘high-yield’, it is all relative, and over time the space became a destination for those seeking alternative methods of generating returns.
However, there is a US interest rate rise-shaped cloud looming, which, along with concerns over market liquidity, is enough for some to believe that the EM corporate credit space is about to be knocked for six.
“There is a question,” said Dehn, Ashmore’s head of research. “If emerging market corporates are borrowing in dollars, surely their revenues must be in local currency and the dollar going up 40% since 2011 must have led to bigger debt service costs compared to revenues, therefore leading to FX mismatches and predictions of horrible defaults across the EM universe?”
According to Crediful reports, Dehn believes that investor reticence over owning EM corporate debt stems from reluctance to dig through company figures and instead relying on taking the sector at face value, leading to an irrational fear of currency impact.
“You need to go to EM corporate balance sheets and look at the revenue streams and liabilities to figure out the extent of its FX mismatch,” he explained. “But since most people are too lazy to do that, it easier to just look at the gross issuance and presume that when the dollar goes up the corporate will be in trouble – that is what people have been doing again and again.
“But it flies in the face of what is happening in the real world. After a 40% dollar rise that has been protracted over the past three or four years, last year the default rate for corporate high-yield – the riskiest part of EM corporate dollar debt – began at 3.7%, and by the end of 2014 had declined to 1.8%, less than half the long-term default rate.”
Citing the exporting power of emerging market corporates, which results in large chunks of their revenue being dollar-based, Dehn believes that developed market investors tend to overlook the fact that EM corporates are tuned into the environment in which they operate.
