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Global Perspective: Renewed Growth in Emerging Markets – A Good Time to Invest

Boosted by a strong world economy and its demand for commodities, emerging markets entered a new phase of recovery and growth in 2016 indicating interesting opportunities for investors.

 

The world economy is for the first time overall synchronously strong. Many economies are expanding and the PMI indicates a stronger world economy generally. Institutions such as the World Bank or the IMF also agree in their positive forecasts. Consequently, demand for commodities in the developed world is strong. One reason for this is the current acceleration of the world economic output, which leads to investments into industrial facilities in developed countries. This late-cycle development generates a large demand for commodities. A second reason is infrastructure investments, as their implementation requires commodities. Last but not least, the funding of e-mobility and its batteries requires an increasing amount of such commodities as copper, nickel, zinc and lithium, because the production of car batteries and the wiring of electric cars entails a higher demand for commodities. This phase of renewed growth has also had a positive effect on commodity prices, such as energy, oil and metal, which in turn is one of the positive influences buoying many emerging market economies.. This phase of renewed growth has also had a positive effect on commodity prices, such as energy, oil and metal, which in turn is one of the positive influences buoying many emerging market economies.

Emerging markets themselves are growing for various reasons. In addition to higher demand for commodities in the developed world, emerging markets themselves boost the consumption of conventional commodities such as coal, oil and gas. In countries such as Indonesia, India, China and also Latin America, a large number of coal- and gas-fired power plants are being built. Renewed growth has also led to new demand for and thus investment in capex projects. One example is the renewed demand of iron ore from China, which has more than doubled the price compared to a year ago.  

Chances for growth are also good, because emerging markets seem generally stronger, more stable and more resilient. During the lean years many emerging markets implemented important structural reforms and many companies implemented restructuring efforts. Many formerly unprofitable sectors have been either sold off or discarded and production costs lowered, readying the economies to get the maximum profit out of a new growth cycle. The effect of this is that EM currencies are strong and EM economies have not reacted negatively either to the stable US Dollar or to the increase in interest rates by the Fed.

 Company leverages in emerging markets are currently much lower than their counterparts in the developed economies, where they are rising. Risk premia of bonds in developed countries have decreased significantly and are in our opinion highly sensitive to interest rate changes. In the emerging markets, by contrast, debt ratios are decreasing and the economies are well prepared for a new investment cycle. A variety of emerging market corporate bonds still possess attractive risk premia. Prime examples of this are Latin America and Africa, which currently still have a lot of potential to close the value gap, presenting interesting investment opportunities. Especially in the commodity sector, there appear to be attractive opportunities. In addition, the ratings are still quite low due to the defensive stance of the rating agencies regarding the commodity price outlook. Thus, it is to be expected that many of the companies, which were downgraded in the years 2014 to 2016, will receive upgrades. For intrepid or contrarian investors this means that the lowering of risk premia can result in additional capital gains. Various other technical factors also indicate the potential of high yield corporate bonds, as the global economic recovery reduces credit risks and actual defaults.

After the low to non-existent rate of new bond issues from 2014 to mid-2016, the rate is now again picking up and presents further interesting investment opportunities. It started off with investment grade bonds in 2016 and since 2017 the number of new issues is rising. Given that the demand for investment in EMs has increased and net inflows have been very high over the last year, the overall demand for new issuances is generally high. However, the market is still sufficiently cautious so that not all companies are able to issue new bonds as investors remain responsible and carefully check investment ideas and plans. Since, as mentioned before, there have been few to no new issuances over the past two years and since emerging markets high yield bonds are usually emitted with a maturity of 5 to 7 years, many bonds that were issued in 2012 and 2013 are reaching maturity in the next 2 years. Consequently, it is to be expected, that many companies will cancel or buy back their bonds prematurely to subsequently place bonds with longer maturities. This will generate additional attractive returns in the emerging market high yield segment. In addition, we expect a lot of new companies to expand their investment universe. The outstanding corporate bond debt universe currently measures 1.94 trillion USD and the volume of new issues will reach 400 billion USD this year. The credit spread continues to be most attractive for the B and BB rated bonds and is generally often more attractive in comparison to developed markets as well as in comparison to other emerging market segments.

These positive events let some speak of a new bull market cycle. If this is the case, then it is still at the beginning and the pace may still pick up. Overall, the generation of solid positive returns is likely to continue given the attractive corporate bond universe, especially in the high yield segment. That is why the MainFirst Emerging Markets Corporate Bond Fund Balanced invests in carefully selected corporate bonds that promise high yields and whose relative attractiveness cannot be found in the fixed income universe.