66 WETENSCHAP & PRAKTIJK
EM Corporate Bonds the new core fixed income staple Unprecedented policy support from central banks and governments around the world helped stabilize markets in the face of COVID-19 in 2020, prompting economic activity to resume, and contributing to a historic decline in bond yields. By Steve Cook and Jonathan Davis
This year, concerns that demand-focused fiscal stimulus may lead to an overheating of economies have caused bond yields to rise. But while rates have broken out of their 2020 ranges, high levels of government debt across developed markets, paired with systemically low rates of inflation, are likely to prolong the low-rate environment. Investors are thus grappling with heightened interest rate volatility in what is still a low-yield environment by historical standards. This means they must reevaluate their core fixed income allocations to ensure that they keep delivering both stability and income throughout a market cycle. We believe that in this environment, certain areas of emerging market (EM) debt have a place in core fixed income allocations, on par with another portfolio staple: US dollar investNUMMER 3 | 2021
ment grade bonds. Specifically, we view the $2.5 trillion universe1 of investment grade debt issued by EM corporate and sovereign issuers in a reserve currency, typically US dollars, as a compelling opportunity set for core fixed income investors. How do yields and spreads measure up? The first point of comparison between investment grade (IG) hard-currency EM debt and US core fixed income is naturally yield – specifically, the potential for EM debt to help solve the challenge of historically low bond yields. Over the past decade, hard-currency investment grade EM debt has typically offered investors roughly 1.10% of excess yield over investment grade US credit, with surprising consistency.2 The consistent relationship between yields on EM investment grade debt and
US IG credit is important for investors looking to enhance core fixed income portfolio yield without introducing meaningful deviation from internal benchmarks. It is also indicative of a similar relationship in credit spreads. Over the past decade, US investment grade credit spreads have occupied a 183 basis point (bp) range, while the ranges for investment grade EM corporate debt and EM sovereign debt have been
237 bps and 188 bps, respectively.3 Given the similarities in yield and spread, it’s not surprising to observe strong relationships with total returns as well: investment grade EM corporate and sovereign debt have shown 0.88 and 0.85 correlations to US credit since 2010,3 respectively. With consistently higher carry and similar trends in credit spreads, investors might assume that invest-
FIGURE 1 EM HARD-CURRENCY INVESTMENT GRADE DEBT HAS OFFERED CONSISTENT EXCESS YIELD OVER US IG CREDIT
Source: J.P. Morgan, Bloomberg Barclays and PineBridge Investments as of 9 March 2021. EM Corp. is J.P. Morgan CEMBI Broad Div. IG, EM Sov. is J.P. Morgan EMBI Global Div. IG, US Credit is Bloomberg Barclays US Credit.
