Looking for Value Across Fixed Income Markets
- There is a lack of yield in ‘core’ fixed income strategies, especially when looking at key benchmarks like the Barclays Agg (2.4%) and the Barclays U.S. Corp Credit (3.4%)
- EM Credit (green bars) offers yields ranging from 5.0% to 9.8%
- Despite downward revisions to global growth and weakening fundamentals, EM GDP growth will outperform the developed world by 1–2% in 2015
- The EM Fixed Income market has grown to a market capitalization of US$1.8 trillion
- EM remains an underallocated asset class and this technical factor should lend ongoing support over the long term
In Fixed Income Markets, EM Offers the Highest Yields
Looking across the fixed income markets, one can readily identify the lack of yield in most “core” strategies. Few people would argue that with the Barclays Agg and Barclays U.S. Corporate Credit indices offering paltry yields of just 2.4% and 3.4%, respectively, key fixed income benchmarks seem unappealing. However, we believe that weak macro trends, particularly in the G7, may continue to favor lower fixed income rates for longer (even with a slight 25–50 bps upward adjustment in short-rates) and within the fixed income universe, EM Credit appears to offer value.
In the chart above, which highlights yields across a select universe of investable fixed income markets, one can see that EM, with yields ranging from 5.0%-9.8%, offers substantially higher yields than just about anything else in the fixed income universe. (EM indices are green in the chart below, dark green=sovereign, light green=corporate). Despite downward revisions in global growth, the differential in EM vs DM growth rates remains decidedly in favor of EM with real GDP among EM countries poised to grow 2.0% faster than the developed world in 2015. We think that developed markets will continue to face headwinds with limited growth, deflationary pressures, and a general lack of credit, pushing out prospects for genuine rate hikes–that impact anything more than the short end of the yield curve–further than most people expect.
EM Credit is a large, diverse and fast growing asset class that has matured over the last decade. In fact, the EM fixed income market has quietly become predominantly corporate. Today, corporate credit represents over 73% of the outstanding EM hard currency fixed income market and is rightfully attracting increased attention from a broader investor base than in the past. The key value driver in this market has historically been that issuing companies typically have better credit metrics than developed world comparables, yet they pay higher yields.
While this concept holds true today, commodity price weakness has a disproportionately large impact on EM issuers and credit fundamentals have deteriorated. Some of this deterioration will be compensated for by currency devaluation which will increase margins and benefit issuers with hard currency revenues.
The investment thesis for EM Credit is further supported by the lower duration of EM corporate debt which, at 4.9 for the broad index and 3.8 for high yield, is significantly lower than most developed market issuers (Barclays Agg=5.7 and Barclays U.S. Corporate Credit=6.5) as well as EM sovereign debt (EMBIG=7.0). Given the higher yields, better credit quality and shorter duration available in EM Credit, one can easily see its allure in a low-yielding, but likely stable, global fixed income environment.
Legal Notice: This material is not financial advice. The information provided is educational and is not intended to be a comprehensive analysis. It is neither an offer nor a solicitation to buy or sell any securities and may not be used or relied upon in connection with any such offer or sale. We believe the information provided herein is reliable, but do not warrant its accuracy or completeness. The statements herein represent the opinions of the portfolio manager of Vaquero Global Investment LP and are subject to change, from time to time, without notice.
