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EM Monitor - The importance of active management in emerging credit investing

February 2021

Unearthing opportunities among EM corporate debt issuers

More than ever, active bottom-up management has been invaluable in navigating the Covid crisis. But what does it mean in the emerging credit space?

By nature, the emerging credit market has lower exposure to Covid-sensitive sectors (retail, airlines, hospitality, etc.) than its developed markets (DM) peers. This may partly explain why the 2020 default rate ended at 3.5 per cent, well under that of the US high yield market (6.7 per cent).1 
EM corporate market less exposed to Covid-sensitive sub-industries than DM
Fig.1 – Market value of covid-sensitive sub-industries (%)
Fig.1 – Market value of covid-sensitive sub-industries (%)

Source: BAML US HY constrained II index for US HY, Bloomberg Barclays US Corporate Index for US IG, BAML EM Corporate Plus index for EM corporate, by BAML sub-industry classification, as of February 2021.

A regional view

Asian companies have shown more resilience during the turmoil. This is probably due to the effective reaction of EM policy makers to the pandemic and the resumption of economic activity ahead of other regions.
Asia appears to have been more resilient to the Covid-19 crisis than other regions

Fig.2 - World GDP growth by major regions and countries: past & forecasts

Fig.2 - World GDP growth by major regions and countries: past & forecasts

Source: Pictet Asset Management, CEIC, Refinitiv. * Bloomberg consensus forecasts for 2021 as of January 21, 2021.

This is not to say that all Asian issuers have done well. Differentiation has increased significantly and made in-depth bottom-up analysis even more crucial.

Bottom-up analysis more crucial than ever

The Covid-19 crisis has introduced new variables that investors need to integrate into their assessments.

  • Countries' reaction to the pandemic and the nature of a company's business

Issuers operating in a highly Covid-sensitive sector with limited or no policy support appear to have been hit the hardest (red box in Fig.3), while companies in less sensitive sectors with strong government support fared much better.

For example, the Chinese government was swift to react with monetary and fiscal support and the PBoC maintained ample liquidity in the system in 2020. This allowed high-yield real estate issuers to access local financing and the sector's bond prices rebounded quickly after Q1. By contrast, Indonesian real estate issuers are in much greater difficulty without government and local bank support.

Not all businesses are on an equal footing
Fig.3 - Governments' response and businesses' sensitivity to the pandemic
Fig.3 - Governments' response and businesses' sensitivity to the pandemic

Source: Pictet Asset Management, February 2021.

But government support is only one part of the equation. Issuers' specific line of business matters a lot, and the reality is very much differentiated within sectors.

In real estate, commercial developers specialised in retail, office rents, or industrial parks - particularly hit by lockdowns - have been strongly impacted. Many saw their credit ratings downgraded. By contrast, the shift to online shopping has increased demand for fulfilment centres, benefiting industrial and logistics property companies. On the residential front, work from home boosted demand for home improvements, proving positive for certain residential home builders.

Another illustration is the resilience of South African gold exporters, despite the relatively poor response from their government in curbing the pandemic.

While government's response and a sector's sensitivity to the Covid-19 crisis are important factors driving a company's resilience, investors still need to perform in-depth company analysis. 

  • Company fundamentals

How a company’s management reacted is vital for its success in navigating the crisis. Did they actively re-negotiate their re-financing terms? Can they cut capex? How sensitive are revenues to domestic Covid policy/ economic activity or global external demand? Does the company have access to local bank financing to improve liquidity? These are all questions that need to be considered as part of active bottom-up selection.

Examples from our EM Corporate team:

1. Impact of proactive liquidity management

A large South African chemicals and energy company, whose products are classified as essentials, saw its bonds plummet in March 2020 partially as its downgrade to high yield by Moody's and S&P led to forced selling by investment-grade investors.

In our analysis, the issuer stood out as extremely oversold given its resilient business profile. More importantly, with limited liquidity support from South African policy makers, its management proactively boosted liquidity by cutting cost, accelerating asset sales and re-negotiating loan covenants. Bond prices rebounded to around par in the second half of 2020.

2. Impact of poor sovereign response

A large Argentina oil & gas company, with greater scope to survive the crisis than many small independent oil & gas producers should have benefited from the rebound in oil prices. But because of the Argentine sovereign debt crisis, the central bank banned that company’s access to dollar capital, which created liquidity stress.

Conclusion

With a lower default rate than US high yield in 2020, the EM credit market has shown better resilience to the Covid-19 crisis than developed markets. 

The Covid crisis will leave scars. Government response and sector sensitivity are important factors to gauge companies' ability to navigate the turmoil. But above all, by amplifying differentiation, the Covid-19 crisis has shown that a multi-dimensional, bottom-up analysis of individual companies' fundamentals is key.