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Tuesday 22 October 2019

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Investment grade emerging markets corporates

Written by Peter Varga
February 2013

ERSTE senior fund manager Peter Varga explains how its ESPA BOND EMERGING MARKETS CORPORATE IG is geared towards the need for yield that is seen among institutional investors

ESPA BOND EMERGING MARKETS CORPORATE IG is a fund that invests exclusively in investment grade corporate bonds from emerging countries. What kind of institutional investors do you hope to attract?
Basically this product is targeted at all groups of institutional investors such as pension funds, insurances, companies, umbrella fund managers, and also banks. The new regulatory criteria such as Solvency II give clearly preferential treatment to bonds in the investment grade segment. This fund combines this specification with the chance to benefit from the performance of emerging markets corporate bonds.

Who manages ESPA BOND EMERGING MARKETS CORPO-RATE IG?
The fund is managed by a team of four investment specialists. The same team also manages about €2 billion worth of assets in fixed income emerging markets, both in hard and local currency.

As senior fund manager I have been primarily responsible for the management of emerging markets corporate bonds since the launch of the fund.

What kind of expertise does the fund management team have when it comes to emerging markets corporate bonds?
Erste Asset Management has been among the pioneers in the Central and Eastern European (CEE) fund business since 1990. We have gradually expanded our ‘home field advantage’ from the CEE countries to the global emerging markets on the back of our local presence. With ESPA BOND EMERGING MARKETS CORPORATE IG, we leverage our experience gained from the ESPA BOND EMERGING MARKETS CORPORATE fund, which has invested successfully in global emerging markets corporate bonds since July 2007.

Due to rising bond prices the fund yield currently amounts to about 3.5 per cent. Why is the fund still attractive to investors?
It’s a question of alternatives. If you compare it to the yield of the so-called risk-free government bonds of Germany and the USA, the yield is indeed still attractive. Many investors have been waiting for a correction, which from our point of view should definitely be used to buy. Investors have a ‘need for yield’ – this applies in particular to institutional investors from developed economies with good ratings.

Many experts have become suspicious of the boom in emerging markets debt; the market is rife with talk of a bubble. What is your opinion on this situation?

The long-term positive trend is intact, and it is supported in particular by the demographic development. The average age of the population in the emerging markets is below that in the industrialised nations. Income per capita will multiply and thus spawn a middle class with a strong propensity to consume. As a result, economic growth in the emerging countries outperforms growth in the industrialised nations, and the ratings of the former improve – much like in Korea, where Moody’s has upgraded the rating to Aa3 only recently.

BBB bonds account for about 70 per cent of the portfolio’s net asset value. Why the strong focus on this segment?
First of all: we manage the portfolios on the basis of our own fundamental assessment, not according to the ratings given by agencies. But you are right – the overwhelming majority of companies hail from this rating class. Companies from emerging markets usually receive a rating that is lower than their peers in the developed markets universe. Hence, even though they offer similar fundamentals, BBB-rated bonds in emerging markets would be rated with a single A or even higher only if they belong to the developed markets investment universe. This is also true for higher rated bonds.

Could you give us an example?
Baidu, the Chinese internet search giant. The bond offers a yield of 3.8 per cent for a 10 year maturity in USD, which is above the average yield of the fund. The fundamentals of the company are very sound: market capitalisation of $38 billion, total debt amounting to $1.5 billion, net profit of about $1.5 billion p.a., and a positive net cash position. Furthermore, Baidu’s strong search engine and their focus on the mobile internet business is receiving more and more recognition.

If we now take a closer look at the rating, we find out that despite having an official rating of A-, Baidu trades only 15 to 30 bp below some of the industrial companies in the BBB- or BB+ rating category. Furthermore, the company is rated like Gerdau from Brazil, which operates in a very cyclical environment. In our view, Baidu offers much more stable returns over the coming months than most of their BBB rated peers.

Summing up, fundamentals are more important than the ratings from the agencies.
Exactly. In addition, the investor can benefit from the migration into a higher rating class.

What is the optimum volume of the new fund?
Our current flagship product, ESPA BOND EMERGING MARKETS CORPORATE passed the $500 million threshold last year. In the medium term we are heading for a similar figure for the ESPA BOND EMERGING MARKETS CORPORATE IG fund.

If the new ESPA BOND EMERGING MARKETS CORPORATE IG is successful: would you consider launching a fund for emerging markets high-yield bonds at a later stage?
A pure-play emerging markets corporate high yield fund could be an option. This strategy would target a client group with a clearly defined risk profile.

Peter Varga is senior fund manager at ERSTE Asset management



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