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Before the tipping point: emerging market corporate bonds

By Cornel Bruhin and Andranik Safaryan, Portfolio Managers in the Emerging Markets Team

Rising commodity prices are a blessing for emerging markets. Undervalued corporate bonds are now delivering double-digit returns. Investors in this asset class are well placed to profit from the emerging recovery.

As major producers, emerging economies stand to benefit from rising commodity prices. The weaker US dollar and the Federal Reserve's emerging end to its cycle of interest rate hikes are indications for this development.

This applies not only to Chile, the world's largest copper producer with a market share of 35%, and Indonesia, which controls more than a third of global nickel production, but also to oil producers.

Rising commodity prices also mean higher profits for companies and wages for workers, as well as rising tax revenues. Over time, this has a ripple effect throughout the economy in the form of increased consumption and investment. As a result, emerging market corporate bonds are likely to recover in the coming months from the historically high losses of the past year.

Oil consumption set to rise for decades

The demand for raw materials is being driven by the energy transistion, electric cars and the re-industrialisation of developed countries (back-shifting of production). All this consumes far more raw materials than ever before. At the same time, investment in future production remains at lower levels than a decade ago. In the longer term, this will inevitably lead to even higher prices.

Another driver of fossil fuel consumption is demographics. Many of the seven billion people living in emerging markets today do not own a refrigerator or have access to electricity. The potential for catching up is huge.

As a result of rising prosperity, oil consumption in these countries will continue to rise for decades to come. It is important to remember that a US American consumes 18 barrels (at 159 litres) of oil per year per person. An Indian gets by on a single barrel, and consumption in Africa is even lower.

Drilling platforms and telecom infrastructure

There are many companies from emerging markets that are worth looking at. One is Shelfdrilling from Dubai. It is a spin-off from Trans Ocean, which used to be listed on the SIX. Shelfdrilling rents out a rare commodity: drilling rigs for offshore oil production. Rental prices for these rigs have risen from $40,000 to more than $80,000 a day in recent years. They are likely to rise further as the largest suspected oil reserves lie at the bottom of the oceans.

Nigerian oil and gas producer Seplat is also benefiting from increased demand. The company is heavily in debt. The acquisition of Exxon Mobile's Nigerian operations will triple its revenues. In South America, Argentine oil company Ypf is on the rise. Thanks to the newly opened gas pipeline to Chile, Argentina is becoming an exporter of fossil fuels.

The leverage of companies in the emerging markets is lower than in the developed markets - and at a historically low level.

An interesting company outside the commodities sector is IHS-Towers, founded in Nigeria in 2022. The company rents out telecommunications infrastructure in Africa, the Middle East and South America. Demographics are playing into its hands: more people, bigger data packages and demand. Measured by the number of telecommunication towers, IHS Towers is the fourth largest company of its kind in the world. As an investor, it is also worth taking a look at the Peruvian company Auna. Here, too, the signs point to growth: the private hospital operator is expanding into Mexico and Colombia.

Corporate bonds: Signs of a turnaround

Many emerging markets will start cutting interest rates before the US Federal Reserve, accelerating growth in these countries. The US federal funds rate will soon peak and the US dollar has been on a downward trend since September 2022. The weaker dollar will prompt investors to seek undervalued assets with catch-up potential. The tipping point for emerging market bonds is approaching.

Investors can take advantage of the emerging market recovery today by investing in a highly undervalued asset class with limited downside potential and solid fundamentals.

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