Companies in the U.S. and Europe will need to compete with emerging market firms for debt capital funding in the future, according to emerging market credit experts speaking at the Association for Financial Markets in Europe’s high yield conference last week.
“In a few years’ time we are going to be in a fight between high-yield [issuers in developed countries] and emerging markets for funding,” said Greg Saichin, head of emerging markets and high-yield fixed income portfolio management at Pioneer Investment Management.
“So I think spreads [for emerging market corporate issues] will get wider. I feel upbeat about the whole market; it is going to be a buyer’s market,” he added.
Conference participants said increased issuance will be necessitated by the currently low leverage of emerging market corporates and households, coupled with the global fall-off in bank lending.
“Before, U.S. banks were the drivers of debt capital finance for emerging markets. I think there is going to be a gradual focus on secured deals [debt backed by collateral], as high yield replaces loans,” said Pierre-Marie Boury, partner at law firm Cleary Gottlieb Steen & Hamilton.
Some participants disagreed that increased issuance will translate into higher yields , with Martin Reeves, head of high yield at Legal & General Investment Management, saying that risk premiums will continue to fall as investors become increasingly comfortable with the asset class.
“Although investor focus is on the microeconomic positives, we do not hear much about the political risk. I wonder if that is priced in adequately,” added Boury.
In addition, should a default occur, outcomes for debt holders can be unpredictable.
“The rules of the capital structure are never reflected. It is a very frustrating experience,” said Pioneer Investment Management's Saichin. “The options are between getting 0 percent in a court, or working out a deal with the main shareholder. You never get the amount your place in the capital structure would suggest.”
Despite this shortcoming, Bibi Khonsari, who works in emerging market corporate credit sales at J.P. Morgan, said the asset class’s investor base will continue to grow.
While developed nations’ pension funds are raising their allocations to emerging market corporates, investment is also increasing from local pension funds purchasing debt from their domestic companies.
Since the major indices for emerging market corporates received investment grade ratings, sovereign wealth funds increasingly participate, having previously been barred from the asset class.
Despite emerging market corporate debt being touted as a competitor for established high-yield issuance, Khonsari said investors new to the asset class should “start with better-rated credits, with better liquidity,” before moving on to more typical high-yield issuers.