- Emerging markets credit spreads still offer investment opportunities at current spread levels
- Covid-19 threat and the ongoing economic impact remain challenges
- EM countries benefit from supportive lending programmes, near-zero rates in developed markets
The rapid turnaround of Emerging markets (EM) credit spreads since their March and April record spread was driven by the bottoming-out of fundamentals, the US Federal Reserve supportive actions and attractive valuations. Since developing countries stand to benefit from supportive lending programmes and near-zero rates in developed markets, NN Investment Partners (NN IP) believes that EM hard currency presents a compelling investment opportunity.
The Covid-19 crisis sent emerging market credit spreads to their widest since the global financial crisis. As NN IP stated at the time, this spread widening represented a monumental opportunity for EMD investors. Despite record-high issuance, spreads rallied furiously and are no longer at extreme levels. In this environment, NN IP believes there is still value to be extracted from the asset class.
“During the global financial crisis, in the year that started eight weeks after spreads peaked, EM sovereign credit returned almost 30%. Similar trends can be observed following less severe sell-offs, such as the Greek debt crisis.”Leo Hu, Co-lead portfolio manager EMD HC at NN IP
Therefore, the risk/reward points to remaining invested in EM credit markets, as they are very hard to time and liquidity can be fickle. EM credit will also continue to generate meaningful carry in a world where developed market rates stay close to zero for an extended period.
Although the economic recovery in EMs is far from over, the overall trajectory is gradually turning positive says Hu. He adds that countries are booking incremental progress in treatment, testing capability, health equipment supply chains, social distancing and wearing of masks and that these small gains are helping markets consolidate.
EM countries also benefit from support from the IMF, and the G-20’s Debt Service Suspension Initiative that suspends payments until end-2020 for the poorest member states of the International Development Association means that those countries can better manage existing debt. NN IP identified Angola, Cameroon and Mozambique as Eurobond issuers that stand to benefit from this initiative.
China, the largest bilateral lender to EM, and the US Federal Reserve are two key factors in the stabilization of EM debt. Between debt relief, the cancelling of interest-free government loans and the rework of commercial obligations of certain African countries by China, and the rapid action by the Fed to move rates to zero, in combination with an aggressive buying programme, helped stabilise global credit markets and helped the US primary credit markets reopen, which in turn helped EM primary markets to open and gave EM sovereigns a much-needed source of funding.
“Angola’s economy is under stress because of Covid-19 and the oil price collapse, and approximately 50% of its total external debt is owed to China. According to local press reports, China agreed on a 3-year debt moratorium, which helps to relieve the liquidity pressure and free up cash.”Leo Hu, Co-lead portfolio manager EMD HC at NN IP