NEW YORK, July 3 (IFR) - Worried about a rise in US Treasury
yields, some emerging market investors are shunning high-quality
corporate bonds and reaching down the credit spectrum to reduce
rates sensitivity in their portfolios.
The strategy could boost total returns at a time when credit
spreads have little room to compress further and competition to
outperform benchmark indices runs high among fund managers.
"Investing in emerging markets has become a macro exercise,
where individual credit stories are less important than US
Treasury moves and global liquidity conditions," said Jim
Barrineau, co-head of emerging market debt relative at
US Treasury exposure has been an important component of
performance for emerging market corporate bond funds, accounting
for more than a third of the 7% year-to-date return in the asset
class this year, according to research from Barclays, as yields
have compressed considerably since the start of the year.
But analysts at the bank believe the second half of 2014
will see a reversal of fortune in the Treasury market, and that
the yield on 10-year Treasuries could top 3.10% by year-end.
In the past week, 10-year Treasuries have widened by 15bp
and the stronger-than-expected US jobs data will only add to the
risk of a further spike in yields.
"The challenge for EM corporate bond managers is... to
prepare for a world where there is still some upside for spreads
but a very large risk of a rates sell-off," Barclays strategist
Aziz Sunderji wrote in a note to clients at the end of June.
He recommends investors increase their holdings of
high-spread products, such as lower-rated corporates and
callable subordinated bank debt, while cutting the duration of
Many investors appear comfortable taking on additional
credit risks. "Given where we are in the credit cycle, we don't
expect a significant rise in default risks, so we are
comfortable taking a bit more credit risk and less duration all
else being equal," said Damien Buchet, head of emerging markets
fixed-income at AXA Investment Managers.
While demand for new issues has been strong at both ends of
the credit spectrum, blue-chip corporates have come to rely
increasingly on demand from high-grade investors in the US and
Europe to generate momentum for new deals.
"Emerging market accounts need to have some exposure to
blue-chip corporates, but they are not the drivers and they
don't put in anchor orders anymore," said an origination banker
covering Latin America.
Recent issues from Mexican bread and snacks company Grupo
Bimbo and Chilean state-owned copper producer Codelco both saw
limited involvement from dedicated emerging markets investors.
Bimbo (BBB/BBB) recently sold 10- and 30-year bonds at
yields of 3.925% and 4.875% respectively.
"On an absolute value basis, it's not really where we want
to be," said Buchet at AXA. "A good company does not necessarily
make a good investment."
At the opposite end of the credit spectrum, however,
emerging market investors are upping their bets.
Highly levered Brazilian infrastructure company OAS
(B1/BB-/B+) received a nine-time subscribed order book for its
US$400m seven-year non-call four bond, which offered a yield of
Indonesian developer Pakuwon Jati recently sold a US$168m
five-year non-call three at a yield of 7.125% in a deal that was
15 times covered. The company had to restructure debt just five
While most market participants agree rising rates in the US
remain one of the main challenges for the asset class, some warn
against letting Treasury expectations and absolute yields take
precedence over credit analysis.
"Rather than taking a strong directional view on rates, we
let the credit selection process drive everything," said Jason
Trujillo, senior emerging markets corporate analyst at Invesco.
Managers favouring a more balanced approach say bonds issued
by highly-levered companies can badly underperform in a
downturn, where low liquidity in the secondary market can easily
amplify potential losses.
But even more important is that investors choosing to
allocate to lower-rated corporates do so on the back of a strong
fundamental view on the sector or the credit.
"If you make the wrong fundamental call, you can end up with
losses regardless of what the market is doing," said Trujillo.
(Reporting by Davide Scigliuzzo; Editing by Sudip Roy and Marc