04 May 2021
Loomis Sayles continues to see interest from insurers in emerging market (EM) debt allocations, particularly EM corporates. This focus appears to be driven by the need for diversification, to broaden the "plus" portion of credit portfolios and access potential yield premiums. With all of this in mind, Colin Dowdall sat down with Elisabeth Colleran, Loomis Sayles' long-time emerging market debt portfolio manager, to discuss how EM investing can meet these needs.
Elisabeth, can you talk a little about how long you've been in the EM corporate markets and how you've seen the markets change?
My background basically evolved with the EM corporate asset class. I joined Loomis Sayles 17 years ago as a credit analyst focused on global telecom companies, which included large EM telecom companies. As time passed, I began focusing on EM credits and transitioned to being a portfolio manager in the asset class. To give you some perspective on the growth in EM, back when I was an EM credit analyst, we could have a one-hour meeting and essentially review most of the companies in the EM corporate universe. Now, the opportunity set has expanded to a market capitalization of about 20 times its size back then. There are approximately 1,000 corporate and quasi-sovereign issuers.
What do you think is driving insurance company interest in EM corporate debt?
Bottom line? I think it's a recognition that the asset class can offer an attractive risk and return opportunity set (see chart). And in a very low-yield environment, where insurers need to deploy capital, we believe EM corporate debt can be a strong option.
I think there are two key characteristics of EM corporates that are drawing insurers' attention to the asset class—ratings and yield. The EM corporate universe is skewed toward investment grade. That combined with the potential yield opportunity has been compelling to some insurance investors.
Emerging Market Debt
Strong risk-adjusted returns over the long term
EM debt is often used as a catch-all term, but the sub-asset classes like local currency, sovereign and corporate have distinct characteristics. Why do you think EM corporates in particular can be compelling for insurance investors?
In our view, EM corporate bonds offer insurers a strong value proposition in the EM debt space. Let me start by walking through EM corporates relative to EM sovereigns. EM corporates are a much larger opportunity set, with about five times the number of issuers of EM sovereigns. The EM corporate universe is typically higher quality from a credit ratings perspective. This is notable because, as I've mentioned, ratings agencies can penalize EM companies for the sovereign's weakness. So on a fundamental basis, some corporates are significantly higher quality than their credit ratings indicate. From a default perspective, more recent experience—really the past five years—highlights that EM high yield (HY) sovereign defaults have been higher and lumpier than defaults in the HY corporate space. Last year, we saw a double-digit pickup in the sovereign HY default rate while the default rate in the EM HY corporate space came in at a fairly benign 3.5%. In my opinion, EM corporate valuations do not reflect these advantages. On a matched-ratings basis, EM corporates offer a consistent spread premium to their EM sovereign and developed market corporate counterparts (see charts). That said, we are currently finding opportunities within the EM sovereign space. This segment can offer additional diversification opportunities and the ability to extend duration since EM sovereigns often issue in 30- and even 40-year tenors.
The value proposition for EM largely resides within the corporate asset class
Pivoting to local currency debt, this space may appear enticing because it offers the potential for foreign currency gains and higher yields, but it comes with significant volatility. The risk profile is probably not acceptable for conservative investors with limited risk budgets.
Can you talk about some of the potential opportunities that you see in the EM corporate market?
Over time, the asset class has become more robust with an expansion of sectors and issuers. This has meant more choices for investors. Investing in EM corporate bonds is all about doing your homework. We often find that our best alpha opportunities exist within lesser-known debut corporate issuers. Given Loomis Sayles' depth of research resources, we believe we are well-equipped to mine opportunities in this segment of the market.
It is also critical to understand the inefficiencies EM corporates face from a ratings perspective. When companies come to market, ratings agencies often penalize them because of a lack of track record, small-scale business or sovereign ratings cap. Through deep fundamental research, we work to identify these credit ratings' inefficiencies, which often drive a mispricing of credit risk, and extract the risk premium or alpha.
We have also found the EM corporate universe to be fertile ground for improving credit stories. In contrast to bond issuers in developed markets, I believe EM corporate bond issuers are more often driven to achieve an investment grade rating. We also tend to see EM corporates raising debt for productive purposes versus developed market companies, which may opportunistically raise capital for financial engineering.
We hear insurance companies and consultants talking about EM corporate debt as the "new core" or as an extension of a core allocation. From your point of view, what are some of the considerations in such a move? What might a portfolio look like?
We believe an important first step would be for an insurance company to think about what it wants this piece of its core allocation to look like given the entity's liability requirements or duration objectives. For instance, as a part of the core, what does it mean for maturity and ratings? What about concentration limits? In some conversations with insurance companies, they talk about portfolio country limits. With this information, we can put together a universe that has the potential to generate the yield and return to meet the insurer's needs.
Insurance companies seem to perceive EM corporates as a large, complex and somewhat fragmented market. How do you bring that together from a research perspective, to be able to have really valuable insights that help contribute to a solid portfolio?
Well, it's really all about the research capability. Loomis Sayles has been doing fundamental research for nearly a century. During this time we have learned the most effective ways to research potential investment opportunities.
We acknowledge that EM corporate debt is fragmented across countries and industries. This makes our experience and depth essential. Loomis Sayles has been investing in EM since 1994. We have 20 global research and trading professionals dedicated to EM, located across Boston, London and Singapore. We follow over 70 EM countries and also have industry-focused analysts that handle some of the more commodity-price-driven industries.
Finally, EM corporates are often perceived as being behind when it comes to ESG (environmental, social, governance). What's your view?
I'd say many EM companies are quickly catching up on ESG efforts. They face some unique challenges, but many companies are taking advantage of technological innovation to leapfrog problem areas that are entrenched in developed markets. I believe there are opportunities to have a big impact on ESG measures in EM if you do the work and engage with issuers. Material ESG considerations are embedded in our deep fundamental research and investment processes.
* Source: JP Morgan. Data shown for the period from 12/31/2010 through 12/31/2020.
EM Corporates = JP Morgan CEMBI Broad Index, US HY = JP Morgan US High Yield Index, Euro IG = IBOXX Euro Corporate Index, US IG = JP Morgan US High Grade Index, EM Sovereigns = JP Morgan EMBIG Index, Euro HY = JP Morgan Euro High Yield Index,, US Equities = S&P 500 Index, EM Equities = MSCI EM Equity Index.
Indices are unmanaged and do not incur fees. It is not possible to invest directly in an index.
Past performance is no guarantee of future results
** Source: Loomis Sayles as of 3/31/2021.
Indices are unmanaged and do not incur fees. It is not possible to invest directly into an index.
Past market experience is no guarantee of future results.
This material is provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein, reflect the subjective judgments and assumptions of the authors only, and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted and actual results will be different. Data and analysis does not represent the actual, or expected future performance of any investment product. Information, including that obtained from outside sources, is believed to be correct, but Loomis cannot guarantee its accuracy. This information is subject to change at any time without notice.
There is no guarantee that the investment objective will be realized or that the strategy will generate positive or excess return.
Past performance is no guarantee of future results.