June was marked by outperformance of ‘high yield’ EM countries and in particular the ‘C’ rated segment compared to investment grade counterparts, as shown in the chart below.

Strategist viewpoint

June was marked by outperformance of ‘high yield’ EM countries and in particular the ‘C’ rated segment compared to investment grade counterparts, as shown in the chart below.

contributions-a-la-performance-depuis-le-debut-du-mois-de-juin-treasury-et-spread
The ‘C’ rated rally was fueled by three key drivers:

  1. The hope of a return to structural reforms in countries like Nigeria, Argentina, Egypt and Turkey;
  2. Debt restructuring negotiations under the new G20 framework.  Zambia, for example, finally struck a deal to restructure its US $6.3 bn debt;
  3. A strong push from multilateral and private creditors to have nature conservation and climate considerations embedded into emerging sovereign debt. As an illustration, on 9 May Ecuador concluded the world's largest $1.6 bn “debt for nature” deal to protect the Galapagos Islands.

Looking forward, a main catalyst for EM external sovereign debt performance is the Fed's monetary policy, which is now close to the end of its cycle. In addition, doubts could persist about the willingness of some countries to return to economic orthodoxy. Nevertheless, the conditions are in place and supportive for sustainable and inclusive growth. However, as always, ‘C’ rated countries will need to redouble their efforts to convince investors of their commitment, allowing for more spread tightening.

  • Zouhoure Bousbih

    Zouhoure Bousbih

    Emerging Markets Strategist

Portfolio Manager viewpoint

The economic fundamentals of many EM countries have been challenged for the past 2 decades. Average EM sovereign ratings were negatively impacted by the 2008 crisis. Starting in 2017, ratings improved but were halted by COVID 19 which completely reversed the improving trend. The reopening of EM economies has repositioned the market for an uptrend is ratings supported by growth.

s-&-p-ratio-upgrade-downgrade

What is notable is that the trend for improved ratings emerged during the Fed’s tightening cycle. As we near the end of its hike cycle the trend for improved rates could be even more robust. 

em-gdp-per-capita-in-us-dollar-s-&-p-data

The improving average GDP per capita of the 75 emerging countries in our investment universe reflects this trend to a higher rating profile. Average growth in EMs since late 2021 bodes well for the asset class. A big plus is also the impulsion for inclusive and climate sensitive development which has become a prerequisite for EM countries to develop sustainable growth over the longer term.

  • Sébastien Thénard

    Sébastien Thénard

    Senior global fixed income portfolio Manager

Momentum in EMD: (re) structuring, (re) rating and climate related!

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The fixed income bond market is comprised of different types of debt. Subordinated debt sits at the lower end of the debt stack, just before equity. In case of a default, repayment of subordinated debt will come after the other bond tranches.  This implies that subordinated debt bears a higher risk for investors. Therefore, in return, subordinated debt bonds compensate investors with higher yields. As a result, the asset class offers a compromise in terms of risk and returns, positioning it in the middle of the capital structure, just between equities and senior bond tranches. European banks represent the largest sub-segment of the subordinated debt asset class. This is related to the regulatory framework and its stringent rules in terms of bank capital requirements. Issuing subordinated debt allows banks to increase their capital ratios while at the same time it serves to strengthen their creditworthiness. In 2023, after a turbulent month of March, the subordinated debt market has moved back in the spotlight. The asset class’s valuations have improved, offering an opportunity to gain access to higher yields from subordinated bonds issued generally by investment grade quality signatures. The subordinated debt market is characterised by a strong “euro” bias, resulting from technical factors (European regulatory framework) that favour issuance versus issuing equity to strengthen capital structures. According to Ostrum Asset Management (Ostrum AM), subordinated debt is an instrument which can be used to diversify fixed-income allocations, offering additional yield pick-up. And it can add value to responsible bond allocation as the sustainable subordinated bond market is developing.
10/03/2023
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09/08/2023
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NEWS MARKETS
Read our market review and find out all about our theme of the week in MyStratWeekly and its podcast with our experts Axel Botte, Aline Goupil-Raguénès and Zouhoure Bousbih.
09/08/2023
Reserved for pros