The following reflects the personal views of Evariste Verchere and is provided for informational purposes only. It should not be construed as investment advice.
Credit analysis is not solely about forecasting default.
Although avoiding default is a key aspect of credit strategies, it is only one component. Ultimately, market prices are determined by supply and demand flows, which may arise for various reasons. For example, investors can become forced sellers during periods of outflows, or forced buyers if an issuer is disproportionately represented in a benchmark. Such dynamics can create bottom-up investment opportunities. However, it is essential to ensure investors can tolerate volatility, as changes in market risk appetite can significantly affect credit spreads and drive much of a fund’s profit and loss—even in the absence of changes to credit fundamentals. Fixed income instruments, such as bonds, are also heavily influenced by the risk-free rate of the currency of issuance, which introduces interest rate risk. Generally, the higher the quality of the credit, the greater the exposure to interest rate risk; lower-quality credits, by contrast, carry more credit spread risk. Notably, during a spike in risk aversion, interest rates often fall while credit spreads widen. As a result, risk-adjusted returns can be improved by carefully balancing exposure between interest rate and credit risks—walking a fine line between the two.
There is not one emerging market, but many.
It does not make sense to say we like or dislike all emerging market bonds, as there are significant differences between them. Some are highly rated, with characteristics similar to, or even superior to, those of developed market countries. Some countries are commodity exporters; others are importers. Some are net capital importers, while others are exporters. There is no single “common factor” that unifies this group. This diversity particularly benefits active investors, as it provides the flexibility to adjust portfolios in different ways and adapt to macroeconomic conditions.
There is value in EM credit.
Yes, spreads are tight, and as a result, emerging market credit can appear expensive on a historical basis. However, any assessment of valuations should take into account what is available in alternative asset classes. EM credit may seem expensive in isolation but can still appear attractive relative to other asset classes. Credit spreads have tightened, but fundamentals – though not uniformly, as there is no single “emerging market”—have also improved. Finally, while credit spreads remain tight, yields are attractive, as real rates continue to be elevated.
EM does not have to be risky.
Emerging market credit is not inherently riskier than developed market credit; rather, it is the result of how markets are constructed. There are EM countries and corporates with stronger fundamentals than some developed market peers. There are also short-dated bonds that are less sensitive to credit spread widening than longer-dated, better-rated developed market bonds. The DM/EM classification does not characterise risk in the same way as the IG/HY distinction – how you construct the portfolio is what truly matters. For example, an IG EM short-duration fund could have significantly less risk than a DM high-yield or a DM long-duration government bond fund in certain environments.
We embrace political risk.
Yes, there is political risk when investing in emerging markets; however, these risks are not fundamentally different from those present in developed markets—consider, for example, recent political events involving the UK, France, or the US. Given the wide range of countries within emerging markets, there will always be political developments occurring somewhere. These developments represent sources of idiosyncratic risk premia, which can be diversified across a well-constructed portfolio.
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