Favourable factors boosting emerging markets
Over the last year, emerging market assets have generated significantly better risk-adjusted returns than comparable investments in developed markets. For example, CEMBI high yields achieved equity-like returns while their volatility was only one-third as high. A comparable portfolio without emerging market positions performed weaker than one with EM positions. The MainFirst Emerging Markets Team expects this trend to continue in the coming years.
According to them, the fundamentals of EM corporates are now in the best shape they have been in since the global financial crisis. EBITDA generation has also been strong, growing at 27 percent in the second quarter of 2018. Most importantly, many companies are employing a more prudent approach and the balance sheets of many companies are improving. This means that compared to the previous cycle, CAPEX strategies are more defensive, cash balances are higher and corporate governance has improved. Overall, EM corporates have been deleveraging due to the strong EBITDA generation and moderate new debt issuance.
Moreover, EM default rates have fallen significantly from their November 2016 peak, which strongly indicates the beginning of a new credit cycle. The global growth trend – even if more moderate now – still supports corporate earnings growth further and leads to higher cash holdings and lower debt. On top of that, commodity markets are balanced, which is why the team expects the commodity cycle to continue and emerging markets to be buoyed by this.
Another positive influence should come from the US Dollar, which is likely to weaken in 2019 as the global economy rebalances away from the 2018 US-led growth trend. The team views the recent FED communication as dovish enough and believe that the FED will be particularly careful in further hikes down the road, meaning that the currently foreseen two hikes do not have to happen necessarily in 2019 and will depend on the US and global economy in 2019. The team already predicted a year ago that the US 10-year benchmark yields would be in the range of 2.75-3.25 percent and not up to 4 percent – as assumed by many other market participants. Moreover, since the interest rate differential has narrowed again in the last few weeks and the carry situation is somewhat less attractive than a few weeks ago, the team feels that many investors are still heavily overweight in their US Dollar asset allocation and see this as not based on sound fundamentals.
What this could mean for investors
Based on this, the team expects that EM corporates will be more resilient – even in a bearish economic scenario – than their US and EU high yield peers and are likely to outperform them. The described outlook also leads them to the view that, in terms of risk-reward, credit is a much more attractive asset class than equity – always only if investors have in-depth knowledge and know how to choose well.
The team has acquired and established its expertise over the last 20 years and both their funds show this through their attractive returns. The MainFirst Emerging Markets Corporate Bond Fund Balanced C (ISIN LU0816909955) achieved an annualised performance of 8.2 percent over the last 3 years and currently has an attractive credit margin of 730 basis points while the Investment Grade corporate credit margin in the portfolio has a spread of well over 300 basis points. By comparison, JPM CEMBI Investment Grade is currently at 240 basis points. The MainFirst Emerging Markets Credit Opportunities Fund C (ISIN LU1061984545) achieved an annualised performance of 9.4 percent over three years and currently has a credit margin of almost 1000 basis points.
Regarding the general valuation, the current yields (Yield to Worst) on the two funds’ portfolios are extremely attractive with over 9.8 percent YTW and a credit margin of 730 basis points in the MainFirst Emerging Markets Corporate Bond Fund Balanced and over 12 percent in the MainFirst Emerging Markets Credit Opportunities Fund.