Determining the "right" asset allocation is one of the biggest challenges for investors in 2020. With yields on developed market bonds at or near historical lows, investors may well look beyond their own limits in search of attractive returns to satisfy their earnings needs. Emerging market corporate bonds also benefited last year from the global trend towards lower interest rates and good economic conditions. Nevertheless, this asset class has further potential to deliver decent returns. In a manner of speaking, as an additional earnings component in a broadly diversified portfolio.
Tangible arguments for Emerging Markets
The coronavirus outbreak is currently the dominant topic in the markets. It determines the risk sentiment of many investors. Nevertheless, it is true that long-term macroeconomic trends should return to the centre of attention, at the latest once the virus can be kept in check as soon as possible and sustainably. The big picture still calls for carefully selected investments in emerging markets. Emerging markets have undergone profound changes over the past decades, driven by developments such as demographic trends and growing consumption. The International Monetary Fund (IMF) expects growth in the emerging markets to pick up again this year, with industrialized nations lagging behind in a direct comparison. The more favourable financing conditions resulting from the easing of monetary policy in many emerging markets should have an increasingly positive effect on the growth and profit prospects of companies. In contrast to most industrialized countries, many emerging markets are also in the comfortable position of being able to lower interest rates further in the event of an economic slowdown. Provided that the major regions of the world do not experience a massive, longer-term downturn in their economic performance, in the wake of which the emerging markets are likely to suffer as well.
This development is also reflected in the increasingly broad spectrum of the emerging market corporate bond sub-asset class. The universe of emerging market corporate bonds has grown rapidly in recent years. There are several reasons for this development. For example, default rates on emerging market corporate bonds have so far been lower on average than those on corporate bonds of industrialised countries. This is an aspect that is often underestimated in portfolio allocation.
Within this broader universe of EM corporates, it is also worth taking a closer look at high-yield debt securities, as a relatively attractive spread is available in this lower credit rating range. Sometimes a much higher default rate is anticipated here than is possibly to be expected for 2020. As a result, there are a number of companies that are still favourably valued at current levels. High-yield corporate bonds from the emerging markets can therefore be a good source of returns on the one hand and an ideal diversification instrument for the overall portfolio on the other.
It is important to find well-positioned companies at favourable prices that can increase their value in the long term thanks to growth drivers and are able to compete with their peers. In this respect, an active allocation approach - applying a top-down and a bottom-up perspective - is the order of the day.
The MainFirst Emerging Markets Corporate Bond Fund Balanced is a corporate bond fund which, in line with its relative value philosophy, focuses on undervalued companies from emerging markets with corresponding yield potential. The objective is to achieve long-term capital growth at a similar level of overall risk and to consistently outperform the benchmark index. The average rating is BB. The top 10 positions accounted for almost a quarter of the assets as at the reporting date of January 31, and are broadly diversified both regionally and sectorally.
Authors: Dorothea Fröhlich, Thomas Rutz and Dimitrios Nteventzis, fund managers of MainFirst Emerging Markets Corporate Bond Fund Balanced and MainFirst Emerging Markets Credit Opportunities Fund.