Oct 09 Sep 10 Aug 11 Jul 12 Jun 13 May 14 Oct 09 Apr 10 Oct 10 Apr 11 Oct 11 Apr 12 Oct 12 Apr 13 Oct 13 Apr 14 Basis Points Basis Points PERSPECTIVES The Fertile Soil of Corporate Bond Market May 2014 Key Insights Yerlan Syzdykov Head of Global Emerging & HY Bond Edited by Giuseppina Marinotti Financial Communication Five Reasons to stay tuned in Corporate Bond Market: 1. Opportunities for Investors in the Search for Yield 2. A Mainstream Asset Class That Should Not Be Ignored 3. Potential Long-Term Opportunities Driven by Investor Demand 4. The Value of Dedicated Macroeconomic Research 5. The Need for a Bottom-up Selection Process Emerging Market Corporate Bonds could remain fertile ground for investors with a selective approach The asset class offers attractive yields compared with US corporates Emerging Market Corporate Bonds delivered solid returns over the past decade, attracting huge inflows for most of the period before experiencing modest outflows induced by the recent tapering debate. The resilience of Emerging Market Corporate Bonds is a reflection of the evolution of the asset class, the demand structure and solid fundamentals. Despite the challenges that lie ahead related to the potential for higher US interest rates, domestic and global macro factors and political risks, we believe that Emerging Market Corporate Bonds continue to offer fertile ground for investors with a selective approach. 1. Opportunities for Investors in the Search for Yield EM Corporate bond yields can still help satisfy the search for yield. This is especially true when compared with US corporates, against which they cheapened significantly over the past two years amid rising default rates in EMs, Fed tapering concerns and risk aversion. Spreads Over US Corporates Remain Wide on Historical Basis 120 100 80 60 300 250 200 150 100 50 40 0 EM vs US IG Spread Differential Average Source: Bank of America Merrill Lynch. Data as of March 31, 2014. EM vs US HY Spread Differential Average 1
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 USD Billion PERSPECTIVES The Fertile Soil of Corporate Bond Market May 2014 the size and liquidity of a mature market 2. A Mainstream Asset Class that Should Not be Ignored Today, the size and the liquidity of the EM corporate bond market is comparable to that of mature markets. At $1.1 trillion, the asset class has recently surpassed US High Yield in size, and has become a main building block of EM investments. Asset Class Growth in Historical Perspective 1,400 1,200 1,000 800 600 400 200 0 EM Corporates US HY EM Sovereigns Source: Bank of America Merrill Lynch. Data as of April 30, 2014. EM corporate issuance has risen aggressively in the past few years due to the low interest rate levels in Developed Markets and the efforts by leading corporate issuers to diversify funding sources away from the banking sector in response to global commercial bank deleveraging. A structural broadening of investor base may help to absorb issuance 3. Potential Long-Term Opportunities Driven by Investor Demand With respect to EM demand, a structural broadening of the investor base, particularly from the institutional side, has so far helped to absorb the large corporate supply. Strategic inflows to EM fixed income remained positive last year, reaching $26 billion for the full year 1. Among institutional investors, insurance companies and pension funds in particular have invested in EM bonds and their presence is expected to increase according to OECD estimates 2. Central bank reserve managers and foreign reserve managers, who tend to be conservative investors, have been cautiously diversifying into EMs, while Sovereign Wealth Funds have also entered the market. Given the strategic nature of their mandates, we believe flows from institutional investors are generally stable, althought they are of course likely to recede should there be a severe crisis or noteworthy downgrade events. Turning to US retail and institutional investors, their allocation to emerging markets doubled from 0.7% in 2006 to 1.4% in 2012. This is still relatively small, especially in the context of the EM share of global market capitalization, and suggests the potential for future increases. 1 J.P.Morgan 2014 Outlook: The rate hiker s guide to the EM corporate space, March 2014. 2 Ref in IMF, Financial Stability Report, March 2014. 2
Index 100 @ 19/3/2013 Share % PERSPECTIVES The Fertile Soil of Corporate Bond Market May 2014 Allocation to EM From US Investors Increased but Still Relatively Low 45 40 35 30 25 20 15 10 5 0 EM Bonds are only 1% of Total US Bonds Holdings by US Investors 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 EMs Share of GDP (% of Global GDP) EM Bond Share in Global Capitalization EM Share in J.P. Morgan Global High-Yield Bond Index 39% 13% 11% Source: IMF, Financial Stability Report, April 2014. US investors include retail and institutional investors. The assessment of country risk is crucial when investing in corporate market 4. The Value of Dedicated Macroeconomic Research The macroeconomic framework and the assessment of country risk are significant factors to consider when investing in EM corporates. As global factors such as the slowdown in China's growth and the approaching end of QE in the US are weakening support for EM inflows, domestic EM factors are becoming more important. In this vein, country risk has been a factor in the underperformance of corporates in the fragile five - Brazil, India, Indonesia, South Africa and Turkey - relative to the overall EM corporate index in the recent crisis. Country Risk Counts on Corporate Returns 104 102 100 98 96 94 92 90 88 86 JPM CEMBI BD JPM CEMBI BD FRAGILE FIVES Source: Bloomberg, data as at April 30, 2014. 3
PERSPECTIVES The Fertile Soil of Corporate Bond Market May 2014 Risk factors to consider in this context include electoral calendars, tensions related to the situation in Ukraine and, on a more long-term basis, progress of EMs in achieving sustainable growth paths and implementing structural reforms. 5. The Need for a Bottom-up Selection Process In our view, corporate fundamentals look generally solid. While EM corporates have, in general, raised their debt ratios, gross and net leverage ratios are still in line with US corporates, and even a touch lower than the US in HY. Overall, our assessment of EM corporate balance sheets is positive. Historical Evolution of Gross Leverage in EM HY and US HY 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 EM HY Leverage Source: BofA Merrill Lynch Global Research, data as of September 30, 2013. US HY Leverage A case by case approach is important to understand the ability of specific corporate entities to manage their debt burdens An issue to monitor is the degree to which reliance on external debt financing impacts a borrower's currency exposure. A mismatch between domestic assets and foreign liabilities, which affected sovereign countries in the 90 s, could be a problem for some businesses in the case of a sharp depreciation of local currencies. There is a broad spectrum of gross leverage as of 2Q13 whether viewed from the country or rating category perspective. The wide range of country fundamentals, debt structures, balance-sheet maturities and currency exposures requires a highly selective approach to identifying critical issues and the best-run corporates. 4
PERSPECTIVES The Fertile Soil of Corporate Bond Market May 2014 A Wide Spectrum of Leverage in EM Corporates Chile HY Brazil HY Mexico HY Peru HY Qatar IG Brazil IG Poland HY Russia HY Chile IG Ukraine HY South Africa HY Argentina HY Russia IG Mexico IG Colombia IG 2.9x 2.7x 2.5x 2.5x 2.2x 2.2x 1.7x 1.3x 1.2x 0.9x Source: BofA Merrill Lynch Global Research, data as of September 30, 2013. 5.1x 4.8x 4.3x 4.3x 3.9x 0.0 1.0 2.0 3.0 4.0 5.0 6.0 EM IG Gross Leverage, 3Q13 EM HY Pioneer Investments consider active asset allocation and bottom-up security selection the key drivers for generating alpha In conclusion, the meaningful rise of private-sector debt encouraged by favourable financing conditions reflects the evolution of the EM asset class over the past few years. The result has been the formation of a mainstream asset class that is fertile ground for investors seeking attractive returns. We believe that a case-by-case approach is important, not only to select opportunities in the market, but also to assess the ability of specific corporate entities to manage their debt burdens. This is crucial given the increase in the foreign ownership of debt in some emerging markets, which creates a vulnerability to periods of increased risk aversion and to any unexpectedly rapid increase in US interest rates. Pioneer Investments considers both active asset allocation and bottom-up security selection the key drivers for generating alpha. By looking across the widest possible universe of investments, we aim to create more diverse portfolios that reflect the full market opportunity, while trying to minimize the risk of permanent capital impairment. With experienced portfolio managers and a dedicated team of credit research analysts, we believe we can offer a solid framework for clients who are considering investing in the EM Corporate asset class. 5
PERSPECTIVES The Fertile Soil of Corporate Bond Market May 2014 Important Information Unless otherwise stated, all information contained in this document is from Pioneer Investments and is as of April 30, 2014. Unless otherwise stated, all views expressed are those of Pioneer Investments. These views are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested. This material does not constitute an offer to buy or a solicitation to sell any units of any investment fund or any services. JP Morgan Emerging Markets Bond Index (EMBI) Global Diversified Index is an emerging market sovereign debt index used to measure performance of the asset class. It limits the weights of countries with larger debt stocks by only including a specified portion of these countries' eligible current face amounts of debt outstanding. JP Morgan Corporate Emerging Markets Bond Index (CEMBI) is a global, liquid corporate emerging markets benchmark that tracks U.S.-denominated corporate bonds issued by emerging markets entities. JP Morgan Corporate Emerging Markets Bond Index (CEMBI) Broad Diversified Index is a global, liquid corporate emerging markets benchmark that tracks U.S.-denominated corporate bonds, issued by emerging market entities, including smaller issues to cover a wide array of corporate bonds and more balanced weightings for countries included in the index. JP Morgan Corporate EMBI High Yield Index is an emerging market index used to measure performance of USD denominated high yield debt issued by emerging market corporations. JP Morgan Corporate EMBI Investment Grade Index is an emerging market index used to measure performance of USD denominated investment grade debt issued by emerging market corporations. JP Morgan GBI-EM Broad Diversified Index is a government bond-emerging market index used to measure performance of government bonds (local currency) issued by emerging market countries. The spot rate, also called a spot price, is the price quoted for immediate settlement on a commodity, a security or a currency; the spot rate is based on the value of an asset at the moment of the quote. All indices are unmanaged and their returns assume reinvestment of dividends, and unlike Fund returns, do not reflect any fees or expenses. Index performance is not meant to represent performance of any Pioneer Investments product. It is not possible to invest directly in an index. Used abbreviations: IG = Investment Grade HY = High Yield and bps = basis points Neither Pioneer, nor its representatives are legal or tax advisors. In addition, Pioneer does not provide advice or recommendations. The investments you choose should correspond to your financial needs, goals, and risk tolerance. For assistance in determining your financial situation, please consult an investment professional. Pioneer Investments is a trading name of the Pioneer Global Asset Management S.p.A. group of companies. Date of First Use: May 14, 2014. 6