Public Fixed Income

EMD: Further Room to Run?

July 2020 – 3 min read
Emerging markets debt rallied strongly in the second quarter—and while risks remain ever-present, the asset class may benefit from continued monetary stimulus and the potential for a sharper economic bounce-back in the second half of the year.

After experiencing a sell-off in the first quarter that rivaled some of the largest in history, emerging markets debt (EMD) asset classes rallied back aggressively in the second quarter—but the recovery has not been uniform. As central bank liquidity flooded the system, rates were the first to react, followed by investment grade rated issuers and then high yield. Currencies continued to lag, due in part to their close correlation with commodity prices, although they ended the quarter in positive territory. Looking across the space: 

  • Corporates recovered approximately 60-65% of the spread-widening since the height of the March volatility (60% for investment grade, 65% for high yield).
  • Sovereign investment grade credits recovered about 75-80%, versus about 40-50% for their high yield counterparts.
  • Interest rates essentially made a full recovery, while currencies have recovered 25-30%.
     

EM DEBT YEAR-TO-DATE PERFORMANCE

Source: J.P. Morgan. As of June 30, 2020.
 

Corporates have performed reasonably well, with defensive sectors like telecom, media and technology (TMT), and utilities holding up particularly well through this period of volatility. And while cyclical sectors like oil & gas, metals & mining, and transport were harder hit, they have rallied back notably since March—although some may face additional challenges if we see further increases in coronavirus cases and lockdown measures. That said, certain segments of these industries are more resilient than others. For instance within the transport sector, airlines and airports have been directly impacted, whereas areas like toll roads and gas pipelines have fared better. 

The corporate default picture also looks brighter than it did three months ago. Whereas market estimates at the time were trending toward 10%, today they are much lower on the expectation that many companies are likely to muddle through the crisis in a zombie-like state, given the wave of government support, rather than default. Looking across the space today, we see particular value in the high yield segment of the market. After spreads widened out to over 1,000 basis points (bps) in March, they retraced back to about 700 bps—but remain wide compared to their pre-selloff levels (460 bps), meaning there may still be room to run.
 

EM SOVEREIGN AND CORPORATE SPREADS (INVESTMENT GRADE VS. HIGH YIELD) 

Source: J.P. Morgan. As of June 30, 2020.
 

On the sovereign side, the recovery picture has been somewhat mixed given the large array of sovereigns comprising the universe. We continue to see value in a number of investment grade-rated EMs, including Colombia, Indonesia and Mexico—as well as Brazil, a country that we rate internally as investment grade. Brazil faces a number of challenges, from the severe outbreak of COVID-19 and political scandal to the massive outflow of foreign investment—nearly 15% of all foreign investment has fled the country over the last 18 months.1 That said, the country’s fiscal and monetary policy framework appears to be on very solid footing, and set to withstand even a presidential impeachment if such a scenario were to play out. 

Further down the credit rating spectrum, we believe Armenia, Paraguay, Belarus, Macedonia and El Salvador all offer attractive relative value. We are less positive on some of the more distressed countries—primarily Argentina, Lebanon, Zambia and Venezuela. We are also reviewing certain high yield names that require more multilateral financing, like Tunisia and Pakistan, which we believe are trading at interesting spreads, and we continue to assess their ability and willingness to pay their debts. 

China, of course, will continue to be a major driver of EMs’ economic prospects, and encouragingly, the economic data that we track—from retail and property sales, to industrial production and steel output—all show strong signs of recovery. Manufacturing rebounded about 80-90% very quickly when the economy reopened.2 And while the consumption side of retail has been lagging, its rate of decline improved materially in May—down just 2.8% after seeing a double digit falloff in March and April.3 While we are keeping close tabs on tariff developments between India and China, asset prices in both countries, thus far, have not been materially affected. 

Global trade is likely to be a less positive story. We expect that countries will continue down the recent path of becoming increasingly insular and relying more on domestic production of goods and services—a trend that COVID-19 is accelerating and that may prove to be a long-term structural headwind for EMs. 

Overall, technicals continue to drive the market as the ample liquidity pumped into the system by governments and central banks continues to support asset prices. It’s difficult to say if, or when, this will take a turn in the near term. We’ve seen recent signs that fear may be creeping back into the market—as negative headlines on COVID-19 in the U.S., Brazil and other hotspots are digested—and there are risks to both the upside and downside cases for global recovery. But on balance, we think the continued monetary stimulus, along with the potential for a sharper economic bounce-back in the second half of the year, could provide a tailwind to many EMs.
 

1. Source: Deutsche Bank. As of May 19, 2020.
2. Source: Bloomberg. As of March 31, 2020.
3. Source: Bloomberg. As of May 2020.

Omotunde Lawal, CFA

Head of EMEA Corporate Credit and Emerging Markets Corporate Debt

Cem Karacadag

Head of Emerging Markets Sovereign Debt

Dr. Ricardo Adrogué

Head of Global Sovereign Debt & Currencies

Any forecasts in this material are based upon Barings opinion of the market at the date of preparation and are subject to change without notice, dependent upon many factors. Any prediction, projection or forecast is not necessarily indicative of the future or likely performance. Investment involves risk. The value of any investments and any income generated may go down as well as up and is not guaranteed by Barings or any other person. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

Any investment results, portfolio compositions and or examples set forth in this material are provided for illustrative purposes only and are not indicative of any future investment results, future portfolio composition or investments. The composition, size of, and risks associated with an investment may differ substantially from any examples set forth in this material No representation is made that an investment will be profitable or will not incur losses. Where appropriate, changes in the currency exchange rates may affect the value of investments. Prospective investors should read the offering documents, if applicable, for the details and specific risk factors of any Fund/Strategy discussed in this material.

Barings is the brand name for the worldwide asset management and associated businesses of Barings LLC and its global affiliates. Barings Securities LLC, Barings (U.K.) Limited, Barings Global Advisers Limited, Barings Australia Pty Ltd, Barings Japan Limited, Baring Asset Management Limited, Baring International Investment Limited, Baring Fund Managers Limited, Baring International Fund Managers (Ireland) Limited, Baring Asset Management (Asia) Limited, Baring SICE (Taiwan) Limited, Baring Asset Management Switzerland Sarl, and Baring Asset Management Korea Limited each are affiliated financial service companies owned by Barings LLC (each, individually, an “Affiliate”).

NO OFFER: The material is for informational purposes only and is not an offer or solicitation for the purchase or sale of any financial instrument or service in any jurisdiction. The material herein was prepared without any consideration of the investment objectives, financial situation or particular needs of anyone who may receive it. This material is not, and must not be treated as, investment advice, an investment recommendation, investment research, or a recommendation about the suitability or appropriateness of any security, commodity, investment, or particular investment strategy, and must not be construed as a projection or prediction.

Unless otherwise mentioned, the views contained in this material are those of Barings. These views are made in good faith in relation to the facts known at the time of preparation and are subject to change without notice. Individual portfolio management teams may hold different views than the views expressed herein and may make different investment decisions for different clients. Parts of this material may be based on information received from sources we believe to be reliable. Although every effort is taken to ensure that the information contained in this material is accurate, Barings makes no representation or warranty, express or implied, regarding the accuracy, completeness or adequacy of the information.

Any service, security, investment or product outlined in this material may not be suitable for a prospective investor or available in their jurisdiction. Copyright in this material is owned by Barings. Information in this material may be used for your own personal use, but may not be altered, reproduced or distributed without Barings’ consent.

Related Viewpoints