COVID-19 and lower oil prices have led to indiscriminate selling across EM corporate debt, creating a potentially compelling opportunity in the shorter-dated, higher-yielding segment of the market.
Emerging markets (EM) debt has faced its share of challenges in recent weeks. COVID-19—and the reality of travel bans, school closures and remote working—has affected companies across the globe. Plummeting oil prices, spurred by the Russia-Saudi Arabia price war, have exacerbated the effects, creating a steep headwind for commodity-producing companies in particular. In response, EM corporate debt spreads have widened significantly—most notably in March, when they surpassed levels experienced during periods of volatility in 2016 and 2018, and in some cases, reached the widest levels since the global financial crisis (GFC).
While spreads have started to normalize more recently, they remain wide relative to both history and developed market asset classes—creating what we view as a compelling opportunity.
Yield Curve Inversion
EM hard currency bond funds experienced outflows of $26.1 billion in March, predominantly from ETFs and retail funds. This broad selloff created significant dislocation in corporate debt prices; even companies with sound fundamentals and minimal direct exposure to COVID-19 traded down.
Given the swift and sharp nature of the event—and the ensuing redemption requirements—managers in many cases were forced to sell assets with the highest cash prices. As a result, the short-dated segment of the market, which has historically been less prone to volatility, also sold off. This caused a significant number of yield curves to invert, whereby the short end of many issuers’ curves yielded more than the longer-dated part of the curve. In our view, this has created significant value opportunities in short-dated bonds, as the inherent pull to par on these assets should result in quicker price recoveries.