THE CASE FOR ERGING MARKET CORPORATE BONDS October 2013 THIS DOCUMENT IS FOR PROFESSIONAL CLIENTS AND INSTITUTIONAL/QUALIFIED INVESTORS ONLY. THE CONTENT IS NOT TO BE VIEWED BY, OR USED WITH, RETAIL INVESTORS. THESE US DOLLAR- DENOMINATED BONDS COMBINE HIGH CREDIT QUALITY AND LOW DURATION, MAKING TH A WELCOME ADDITION TO A GLOBAL FIXED INCOME PORTFOLIO avivainvestors.com Aaron Grehan & Tom Williams
Emerging market corporate are a rapidly growing segment of the overall emerging market debt universe. We believe that a strong investment case can be made for investing in emerging market corporate on fundamental, technical and valuation grounds. Key reasons to invest in emerging market corporate : 1. The secular growth of emerging market economies provides an excellent platform for the continued expansion of local companies. The emerging corporate bond universe now encompasses over 1000 issues in 42 countries. 2. Historically, emerging market corporate have demonstrated a low level of correlation to developed bond markets. This means such can provide excellent portfolio diversifcation or a highly effective satellite allocation alongside sovereign emerging market debt investments. 3. Average duration is around a year and a half shorter than for emerging market sovereign, helping to mitigate the effect of rising interest rates. 4. The credit fundamentals for the sector as a whole continue to improve. Today the Corporate Emerging Markets Bond Index Broad (CBI) is rated Baa2/BBB by Moody s and Standard & Poor s, one notch higher than the emerging market sovereign bond market, with 71 per cent of corporate issues now rated investment grade. 5. Many emerging market governments are now reining in their external borrowing at a time when international demand for higher-yielding assets remains acute. Demand for US dollar-denominated emerging market corporate should beneft from this, helping to underpin the substantial new issuance forecast for the years ahead. Aaron Grehan, CFA Emerging Market Debt Fund Manager Aaron joined the investment industry and Aviva Investors in March 2000. He was previously a credit fund manager in the liabilitydriven fxed income team managing portfolios for institutional clients. Aaron joined the credit team in 2004 as a portfolio analyst before becoming an investment analyst in both the LIDFI and Credit teams. Aaron is a CFA charterholder and holds the investment management certifcate. Thomas Williams Client Portfolio Manager, Fixed Income After joining the investment industry in 2005, Thomas moved to Aviva Investors in 2008 developing broad product expertise, with a focus on alternative investments and tailored solutions for institutional investors. Thomas holds a BSc in Economics and Econometrics from the University of Nottingham. He holds the Investment Management Certifcate (IMC) and is a CAIA charterholder. 2 The case for emerging market corporate October 2013
THE FUNDAMENTAL CASE The relative strength of emerging market economies continues to be benefcial for local companies. With only a limited supply of hard currency sovereign, emerging market corporate look set to fll the space. Despite the headwinds facing global economic growth, emerging market countries are continuing to grow at a substantially faster pace than developed economies. This growth provides a favourable investment backdrop for the corporate sector as more emerging markets frms look to expand. In 2010, emerging market economies accounted for 38 per cent of world GDP. This is expected to have risen to 49 per cent by the start of the next decade in 2020, and by 2030 emerging economies are forecast to comprise 59 per cent of world GDP 1. There are also signifcant diversifcation benefts from investing in emerging market corporate. Historically, they have demonstrated a low correlation to more mainstream asset classes; particularly the major government bond markets such as US treasuries (see Figure 1: Correlation analysis). This means they can provide excellent portfolio diversifcation or a highly effective satellite allocation alongside more traditional emerging market debt investments. 1. Source: Goldman Sachs forecasts 2011 Figure 1: Correlation analysis corporate (US$denominated) (local currency) (US$denominated) infationlinked (local currency) corporate (US$denominated) (local currency) infationlinked (local currency) US Treasuries Euro government US corporates highyield convertibles equities 1.00 0.68 1.00 0.93 0.75 1.00 0.72 0.83 0.75 1.00 US Treasuries 0.14 0.04 0.21-0.18 1.00 Euro government 0.10 0.06 0.16-0.12 0.58 1.00 US corporates 0.84 0.54 0.81 0.54 0.43 0.31 1.00 high- yield convertibles 0.81 0.69 0.80 0.75-0.24-0.15 0.66 1.00 0.77 0.82 0.77 0.80-0.11-0.07 0.64 0.84 1.00 equities 0.67 0.79 0.66 0.76-0.27-0.19 0.45 0.82 0.91 1.00 equities 0.69 0.83 0.71 0.85-0.21-0.14 0.48 0.79 0.87 0.91 1.00 equities Source: Aviva Investors Strategy Team as at 31 March 2013. All statistics are on a fve-year annualised, unhedged in USD basis unless otherwise stated. local currency = JP Morgan GBI- Broad Diversifed Index (US$ unhedged); (US$-denominated) = JP Morgan BI Diversifed Index; infation-linked = Barclays Government Infation-Linked Bond Index; corporate = JP Morgan CBI Broad Diversifed Index; US Treasuries = JP Morgan US Govt Bond Index; Euro government = FTSE Govt Eurozone All Maturity Index (US$ hedged); US corporate = BofA ML US Corp Master Index; high-yield = 85% ML US High Yield Index + 15% ML Euro High Yield Index; convertibles = UBS Convertibles Focus Index; equities = FTSE World (US$ unhedged); equities = MSCI Emerging Markets (US$ unhedged) The case for emerging market corporate October 2013 3
The credit fundamentals offered by emerging market corporate have been improving steadily. In 2000, over 60 per cent of emerging market corporate were rated below investment grade as high yield. Today, 71 per cent of the market capitalisation for emerging market corporate universe is rated investment grade and only 29 per cent is high yield 2. The chart below gives a more detailed breakdown by region. The Corporate Emerging Markets Bond Index Broad (CBI) is rated Baa2/ BBB by Moody s and Standard & Poor s, one notch higher than the Emerging Markets Bond Index (BIG), which tracks emerging markets sovereign. The trend towards investment grade is expected to continue; over 75% of issuance for the remainder of 2013 is expected to achieve investment grade ratings 3. Signifcantly, the improving credit fundamentals of emerging market countries have reduced the need for many emerging market governments to borrow in external debt markets, where are issued in dollars or euros, for example, rather than the borrower s own currency. Falling sovereign issuance creates space in the external market for alternative sources of emerging market debt to meet the sustained investor demand for higheryielding assets. Defensive attributes Another factor to consider is that emerging market corporate indices typically offer shorter duration than emerging sovereign bond markets approximately one and a half years shorter. This reduced sensitivity to changes in interest rate expectations offers investors some protection in uncertain market conditions. This was illustrated during the summer of 2013 as US treasury markets endured volatile conditions. Emerging markets corporate were able to outperform compared to longer duration sovereign debt. Chart 1: Ratings and region breakdown for Corporates Aa1 Rated Aa3 Rated A1 Rated A2 Rated A3 Rated Baa1 Rated Baa2 Rated Baa3 Rated Ba1 Rated Ba2 Rated Ba3 Rated B1 Rated B2 Rated B3 Rated Caa1 Rated Caa2 Rated Caa3 Rated None 0% 5% 10% 15% 20% Asia Latin America CEEA Other Source: Aviva Investors as at 31 October 2013 2. Source: JP morgan as at 31 August 2013 3. Source: JP Morgan, 09/09/2013 4 The case for emerging market corporate October 2013
THE TECHNICAL CASE With new emerging market sovereign bond issuance shrinking, the demand picture for emerging market corporate looks robust. Meanwhile, faced with constrained local bank lending, emerging market companies have been turning to the bond markets creating a strong pipeline of expected issuance. The robust growth of the corporate bond markets in emerging economies is illustrated by the breadth and depth of issuers that now constitute the JP Morgan CBI Broad Diversifed Index. This index comprises almost 1000 issues, with an average credit rating of BBB (investment grade), across 42 countries. The Asian markets make up the largest segment (approximately 40 per cent), followed by Latin America (27 per cent), the Middle East (15 per cent), Europe (14 per cent) and Africa (four per cent). Emerging market debt strategies saw record infows in 2012, with investors preferring the defensive qualities of hard currency. Strong demand for emerging market corporate continued into 2013, despite the recent volatility in emerging debt markets and the outfows that have resulted. Taking a longer term view, many institutional investors, particularly in the US and Japan, still have plenty of scope to increase their allocations to emerging market debt. Many have no long-term exposure to the asset class and will need to rebalance in order to capture a globally representative opportunity set. Supply and demand From the supply angle, net sovereign issuance in external debt for 2013 is forecast to be in the region of US$10 to US$15 billion 4, relatively low by historical standards. In contrast, emerging market companies are expected to present further substantial new issuance enabling them to capitalise on the low interest rates on offer and the substantial international demand for higher-yielding assets. The bond markets offer local companies competitive long-term fnance, compared to bank lending, which remains constrained. In fact, over the last three years, emerging market corporates have been the fastest growing fxed income asset class. Figure 2: 2013 gross bond issuance by region (US$m) 2013 YTD 2013 Remainder 2013 Full year forecast Asia 94,661 25,413 120,074 Emerging Europe 56,822 17,178 74,000 Middle East and Africa 24,776 10,974 35,750 Latin America 63,358 21,642 85,000 239,617 75,207 314,824 Source: JP Morgan, Bondradar as at 9 September 2013 4. Source: JP Morgan 09/09/2013 The case for emerging market corporate October 2013 5
THE VALUATIONS CASE The correction in emerging bond markets seen over the summer of 2013 has put the asset class in a favourable position relative to other fxed income and created an attractive entry point for new investors. Both fundamental and technical factors present an attractive case for emerging market corporate, the yields on offer represent a signifcant pick-up on developed market credit for incomeorientated investors. Although spreads on emerging market have fallen signifcantly since the height of the global fnancial crisis in late 2008, and are now at c330bps (as at 31 October 2013) over US treasuries, they are still far above the precrisis lows of c160bps 5. As illustrated below, the yields on emerging market corporate debt compare favourably with developed markets and other fxed income assets. Spreads on emerging markets BBB-rated have widened to around 1.7 times those on equivalently-rated US 6. This suggests investors in emerging markets are able to access higher yields, without taking on additional credit risk. Overall, we believe that this combination of attractive fundamental, technical and valuation data presents a compelling longterm investment case for emerging market corporate as part of a diversifed, international portfolio for institutional investors. Chart 2: Fixed income yields (%) 7 6 5 4 3 2 1 0 high yield hard currency debt corporate debt investment grade corporate government, G7 Source: Bloomberg as at 31 October 2013 5. Source: Bloomberg as at 31 August 2013 6. Source: Bloomberg as at 31 October 2013 6 The case for emerging market corporate October 2013
WHY AVIVA INVESTORS FOR ERGING MARKET CORPORATE BONDS? Our long-standing expertise in emerging market debt means we re ideally positioned to capitalise on the opportunities available in this growing market. 1. Aviva Investors has been investing in emerging market since 2000, making us one of the UK s frst global fund managers to enter this space. We have a dedicated and experienced team, which has grown alongside the expansion of our capabilities into local markets, infation-linked and now emerging markets corporate. 2. We have the scale and resources to succeed in a competitive landscape. Our team now manage over $4bn in emerging markets debt and are able to draw on the expertise of a global asset management organisation. This includes our other fxed income teams in global sovereign and credit markets, economists, strategists, quantitative analysis and the specialist insight on Asian provided by our six-man fxed income team based in Singapore. 3. At Aviva Investors, we believe in a disciplined, conservative investment approach designed to deliver sustainable long term outperformance. By avoiding negative shocks, we aim to capture investment opportunities while offering downside protection. This approach is employed across all our emerging markets debt strategies and has been key to delivering our highly successful track record over the last 13 years. Important information Except where stated as otherwise, the source of all information is Aviva Investors Services Limited ( Aviva Investors ) as at 30 September 2013. Unless stated otherwise any opinions expressed are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Some of the information within this document is based upon Aviva Investors estimates. It is not to be relied upon for the purpose of making investment decisions. This document should not be taken as a recommendation or offer by anyone in any jurisdiction in which such an offer is not authorised or to any person to whom it is unlawful to make such an offer or solicitation. Aviva Investors Services Limited, registered in England No. 1151805. Registered Offce: No. 1 Poultry, London EC2R 8EJ. Authorised and regulated in the UK by the Financial Conduct Authority and a member of the Investment Management Association. This document is prepared by Aviva Investors Services Limited, authorised and regulated in the UK by the Financial Conduct Authority and a member of the Investment Management Association. It is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited for distribution to investment professionals only. Recipients of this document are to contact Aviva Investors Asia Pte. Limited in respect of any matters arising from, or in connection with, this document. Please note that Aviva Investors Asia Pte. Limited does not provide any independent research or analysis in the substance or preparation of this document. Recipients of this document are to contact Aviva Investors Asia Pte. Limited in respect of any matters arising from, or in connection with, this document. Aviva Investors Asia Pte. Limited, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and is an Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Offce: 6 Temasek Boulevard, #32-08 Suntec Tower 4, Singapore 038986. MC2801-V007-303578-13/1056/280214-20131216_02