UNDISCOVERED OPPORTUNITIES IN EMERGING MARKET CORPORATE BONDS Emerging market corporate debt offers investors a high-quality universe of securities that exhibit higher yields and lower correlation than other asset classes. Adding emerging market corporate bonds to a portfolio of U.S. stocks and bonds can create a more efficient portfolio.
VALUATIONS AND CORRELATIONS OF EMERGING MARKET CORPORATE BONDS As emerging market (EM) corporate bonds become a more mainstream and established asset class, the comparison between them and more traditional investment securities is important to understand. EM corporate bonds offer a yield advantage compared to similarly rated U.S. investment grade and high yield bonds and intrinsically should provide superior returns than developed market (DM) bonds in a U.S. Treasury rate-rising environment. Yields for EM corporate bonds can be higher and trade at wider spreads than their developed market peers, while retaining low correlation. As such, they can become a solid diversifier to a fixed income portfolio for some investors as seen in the table below. Asset Class Representative Index Spread Yield Duration Avg. Credit Quality Correlation to Barclays Capital Aggregate Bond Index Correlation to S&P 500 Index EM Corporate JP Morgan Corporate EM Bond Index Broad 393 5.74 5.21 BBB 0.37 0.56 EM Investment Grade Corporate JP Morgan Corporate EM Bond Index Investment Grade 270 4.52 5.66 BBB+ 0.57 0.41 EM High Yield Corporate JP Morgan Corporate EM Bond Index High Yield 631 8.12 4.37 BB- 0.07 0.70 EM Sovereign JP Morgan EM Bond Index Global Diversified 369 5.57 7.16 BB+ 0.49 0.43 U.S. Fixed Income Barclays Capital Aggregate Bond Index 70 2.07 5.45 AA 1.00-0.30 U.S. Investment Grade Credit Bank of America Merrill Lynch U.S. Corporate Index 136 2.96 7.13 A- 0.86 0.06 U.S. High Yield Credit Bank of America Merrill Lynch U.S. High Yield Index 482 6.63 4.39 B+ 0.15 0.76 Source: JP Morgan, Barclays Capital and Bank of America Merrill Lynch as of 3.31.15 Improvement in Risk Characteristics by Including Emerging Markets Index By adding an allocation of EM corporate bonds, the efficient frontier has shifted up and left, due to the low correlation to the U.S. assets. This shift has allowed investors to earn a similar return by taking on less risk, or to earn a higher return at the same level of risk. Return (%) 8.2 8.2 8.1 8.1 8.0 8.0 7.9 7.9 7.9 7.8 7.8 7.7 7.7 7.6 Allocation (Ret=8.0; Risk=10.1) Barclays Capital Aggregate Bond Index 30% Barclays Capital U.S. Corporate High Yield Index 21% JP Morgan Corporate EM Bond Index 17.9% Allocation (Ret=7.8; Risk=9.6) Barclays Capital Aggregate Bond Index 35.8% JP Morgan Corporate EM Bond Index 14.2% Allocation (Ret=8.0; Risk=10.34) Barclays Capital Aggregate Bond Index 35.5% Barclays Capital U.S. Corporate High Yield Index 14.5% Allocation (Ret=7.8; Risk=9.8) Barclays Capital Aggregate Bond Index 40.3% Barclays Capital U.S. Corporate High Yield Index 9.7% 7.6 7.5 7.5 7.5 9.0 9.1 9.2 9.3 9.4 9.5 9.6 9.7 9.8 9.9 10.0 10.1 10.2 10.3 10.4 10.5 10.6 10.7 10.8 Portfolio Risk General Portfolio Improved Portfolio Including EM Index Source: FactSet and JP Morgan, rolling 1-year returns from 1.1.02 to 3.31.15 Portfolio risk is measured by standard deviation of the returns.
THE EMERGING MARKET CORPORATE BOND UNIVERSE Size of Universe Total Debt Outstanding (US$Billion) The EM corporate bond universe is large, having tripled over the last five years and valued by JP Morgan at approximately $1.6 trillion (as of March 2015). The universe is heterogeneous and well-diversified by region, country and industry. 2000 1500 1000 EM Corporate US High Yield EM Sovereign This universe encompasses over 70 countries, which provides opportunities to diversify and take advantage of different economic cycles. 500 0 1993 1998 2003 2008 2009 2010 2011 2012 2013 2014 QTD 2015 Source: JP Morgan as of 3.31.15 Quality of Securities Average Credit Quality The majority (approximately 70%) of EM corporate bonds are rated investment grade. These ratings have converged with the rating of DM, making them an attractive way to diversify a portfolio. Shifting from lower quality high yield bonds into EM corporate bonds can increase the quality and diversification of an portfolio without sacrificing yield. A- BBB+ BBB BBB- BB+ BB BB- B+ EM Sovereign EM Corporates US Corporates 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: Bank of America Merrill Lynch as of 3.31.15 Fundamentals One of the biggest misconceptions about EM corporate debt, that these companies are a riskier investment, we believe is incorrect. If you look at the balance sheets of these companies, you ll see they are actually managed more conservatively than companies in the developed world. Leverage is lower across the credit quality spectrum and they run structurally higher cash balances as a proportion of total debt than DM corporates. Furthermore, given that the vast majority of these companies adhere to international reporting standards and many have outstanding public equity, issues of transparency and access to management are no longer impediments to investment. Leverage in EM and DM (Net Debt/EBITDA) 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Developed Market Emerging Market 1.31 1.20 2.24 A BBB Investment Grade 1.67 Source: Bank of America Merrill Lynch as of 3.31.15 3.13 BB 2.85 High Yield 4.57 B 3.70 Inefficiency and Alpha Potential Given the heterogeneous nature of the universe, there is tremendous opportunity for active managers to select credits. With significant dispersion of returns, the market is increasingly doing a better job of differentiating between good and bad credits and improving versus deteriorating stories. This lack of contagion is positive for this universe, particularly as geopolitical and idiosyncratic headline risks have been elevated. Last 12 Months Total Returns 30% 20% 10% 8% 6% 4% 2% 0% -2% -4% -30% -40% Ukraine Brazil Russia Macau Kazakhstan Colombia Jamaica Saudi Arabia Indonesia CEMBI Div. South Africa Bahrain Qatar UAE Kuwait Korea Guatamala Argentina Chile Mexico Poland Singapore India Hong Kong Israel Peru Philippines China Hungary Malaysia Turkey Thailand Czech Rep. Dominican Rep. Source: JP Morgan as of 3.31.15
HOW TO ACCESS EMERGING MARKET CORPORATE BONDS Each of the below strategies can be implemented using a combination of hard and local currency. Approach Targeted Allocation Broad Allocation Unconstrained Allocation Scope Invest in a product that exclusively buys EM corporate bonds. Invest in a product that buys both EM corporate bonds and EM sovereign debt. Benchmark agnostic, absolute return strategy geared to deliver positive returns irrespective to the underlying market environment. Benefits Investor can choose a manager whose strategy and beliefs align with their own without having to research and trade individual bond issues. Retains precise control over how much of a portfolio is invested in EM corporate bonds. Investor benefits from manager having full authority to use expertise in EM corporate bonds of both sovereigns and corporations. Investor benefits from manager having full authority to use expertise in wide range of debt instruments while also making tactical decisions across bond sectors. Drawbacks Manager is limited to EM corporate bonds and cannot buy other sectors, even if there are good opportunities elsewhere. Manager is limited to EM corporate and sovereign bonds and cannot buy other sectors, even if there is good opportunity elsewhere. Allocation to EM corporate bonds will only be a slice of overall allocation. Vehicles may not always be suitable for all investor types.
BLUEBAY ASSET MANAGEMENT In excess of $50 billion in assets under management Over 400 staff, approximately 25% are investment professionals Diversified institutional and financial intermediaries client base We are next generation fixed income specialists. BlueBay was founded in 2001 in response to opportunities in the European corporate debt market, and in anticipation of the expansion of EM fixed income as an institutional asset class. Then as now, we aim to offer clients new thinking and fresh opportunities. With our hedge fund heritage and by staying true to our specialist fixed income roots, we pioneer new investment strategies using our broad range of sub-asset class expertise, with a focus on absolute return and capital preservation. Emerging Market Corporate Debt Team is: an international, multi-lingual team with deep roots in EM from diverse backgrounds with complementary skill sets a solely London-based team which facilitates quick decision-making continuously leveraging the expertise of our 20+ person EM sovereign team Head of Desk Polina Kurdyavko Senior Portfolio Manager Average Team Industry Experience 6 Portfolio Managers 12 years 6 Credit Analysts 8 years 2 Traders 20 years 14 Total 11 years RBC GLOBAL ASSET MANAGEMENT Over $300 billion in assets under management 1,338 employees worldwide 337 investment professionals Offices in the United States, Canada, Europe and Asia RBC Global Asset Management (RBC GAM) fosters a culture of risk management, investment and service excellence. With experienced investment teams in the United States, Canada, Europe and Asia, investors around the world have access to our globally integrated investment platform and comprehensive range of resultsdriven investment strategies. Contact Us RBC Global Asset Management (U.S.) Inc. 50 South Sixth Street, Suite 2350 Minneapolis, Minnesota 55402 800.553.2143 us.rbcgam.com All figures as of March 31, 2015
The JP Morgan Corporate EM Bond Index Broad is an unmanaged index consisting of U.S.-dollar-denominated emerging market corporate bonds. The index limits the weights of those index countries with larger corporate debt stocks by only including a specified portion of these countries eligible current face amounts of debt outstanding. The JP Morgan Corporate EM Bond Index Investment Grade is an unmanaged index made up of U.S. dollar investment grade corporate emerging market bonds representing Asia, Latin America, Europe and the Middle East/Africa. The JP Morgan Corporate EM Bond Index High Yield is an unmanaged index made up of U.S. dollar corporate emerging market bonds representing Asia, Latin America, Europe and the Middle East/Africa, restricted to those that have a maximum rating of BB+ by S&P or Ba1 by Moody s (based on the higher of the two). The JP Morgan EM Bond Index Global Diversified is an unmanaged index made up of U.S. dollar denominated Brady bonds, Eurobonds and traded loans issued by sovereign and quasi-sovereign entities. It defines emerging markets countries with a combination of World-Bank-defined per capita income brackets and each country s debt-restructuring history. The Barclays Capital Aggregate Bond Index is an unmanaged index made up of investment grade Treasury securities, mortgage-backed securities (MBS) foreign bonds, government agency bonds and corporate bonds. The BofA Merrill Lynch U.S. Corporate Index an unmanaged index that tracks the performance of U.S. dollar denominated investment grade corporate debt publicly issued in the U.S. domestic market. The BofA Merrill Lynch U.S. High Yield Index an unmanaged index that tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the US domestic market. 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