In a yield-starved and uncertain West, emerging market corporate bonds denominated in U.S. dollars could offer investors attractive opportunities, according to the latest Western Asset commentary.
In the past few years, emerging market corporate bonds denominated in the dollar have generally posted healthy returns.
Going forward, these bonds should continue to offer high yields. Moreover, they offer the possibility of enhanced total returns if investors continued to bid up their price.
The Western investment community has long acknowledged the superior long-term economic growth of emerging market countries.
However, it has been hesitant to invest in their corporate bonds markets because of liquidity and default concerns.
Emerging market countries, for example, were prone to financial shocks like the Asian financial crisis of the late 1990s and the Argentine sovereign debt default.
There is also transfer risk, which is the possibility that an emerging market country's government will prevent a company from repaying debt, even if the company could afford to do so.
In 2012 and beyond, however, many governments of emerging market countries actually have better balance sheets than the governments of developed countries, thanks to years of fiscal and monetary discipline. Emerging market countries still retain their growth advantage.
The perceived safety of their corporate debt, relative to developed market corporate debt, has therefore improved.
In the past, liquidity was a concern for dollar-denominated emerging market corporate bonds because emerging market sovereign bonds were the far more liquid space. Investors prize liquidity, especially for investments they perceive to be risky, because illiquid assets fare poorly during financial panics.
In recent years, however, U.S. dollar-denominated emerging market corporate bonds have become much more mature and liquid. In fact, since 2003, U.S. dollar-denominated emerging market corporate bond issuance has outpaced emerging market sovereign bond issuance.
These improvements in fundamentals may eventually induce more institutions in the Western world to incorporate U.S. dollar-denominated emerging market bonds into their portfolios.
Currently, Western Asset believes developed economy creditors have little existing exposure to this asset class through ETFs, dedicated mutual fund assets and asset tied to indices.
If more institutions jump on board, those who bought emerging market corporate bonds earlier will likely benefit from price appreciation and increased liquidity.
U.S. dollar-denominated emerging market corporate bonds will increasingly become a viable option for global bond investors seeking to capitalize on the positive long-term secular investment story offered by EM countries, stated Western Asset.
These assets may have some disadvantages, however.
Compared with local currency emerging market corporate bonds, they may offer lower returns if the U.S. dollar depreciates against emerging market currencies. In times of financial panic, U.S. asset managers may still have the tendency to switch from emerging market financial assets to U.S. financial assets like Treasuries.