EM Corporates Still Have Room for Further Spread Compression, Say EM Corporate Bond Panelists
EMTA's fourth annual Corporate Bond Forum in London was held on Tuesday, January 27, 2010. ING hosted the event, which attracted a standing room only crowd.
Moderator David Spegel of ING opened the panel by polling speakers for their thoughts on whether the corporate bond market had reached "bubble" status. BlueBay Asset Management's Polina Kurdyavko still found corporate bonds attractive at current levels. However, she reiterated her concerns, expressed at several previous EMTA Corporate Forums, on bond covenants that fail to adequately protect bondholders, and described several examples of bond covenants being more lenient than in 2007. "I would urge bondholders to push to improve covenants," she stated, while adding that she would "forego the spread for better covenants."
Esther Chan of Aberdeen Asset Management reviewed the history of corporate bond pricing and reasoned that while "we are not now in a bubble, we are setting ourselves up for one. We probably have a few months--not years--of tightening before we can argue the asset class is at the bubble stage." She urged investors to be selective when buying corporate issues.
JPMorgan's Victoria Miles agreed that there is "still room for spread compression and it doesn’t feel to us like we are in a bubble." 'She commented that even those recent issues perceived as covenant-lenient have still attracted strong interest from US high-yield buyers.'
With panelists largely concurring that the asset class was not in a bubble, Spegel asked panelists the remaining risks facing EM corporate bondholders. Miles admitted that the recent Dubai incident "blindsided" investors; as a result a more discerning approach to quasi-sovereigns had generally been adopted. She viewed commodity pricing as a risk, specifically a China-driven slowdown in oil pricing could harm CIS and Middle East issuers, although she assigned a low probability to this concern. Miles also discussed supply risk, with potentially increased supply coming from CIS issuers needing to refinance.
VTB's Ivan Ivanchenko discussed a strong dollar being a potential issue for corporate issuers. He also highlighted the political uncertainty in the Ukraine, which could possibly trigger a new round of risk aversion. Kurdyavko added event risk, with much more M&A activity likely to take place, and the execution risk of corporate management. She also expressed concerns that quasi-sovereigns could be harmed by political interference, with governments using them as vehicles to advance social policies.
How should investors position themselves for the expected rate tightenings by the US FOMC and ECB? "I am worried by a potential bubble if tightening is too little, or not done quickly enough," noted Chan, who advised investors that "short duration, high carry is a good place to be...but you still have to like the company's fundamentals." Miles noted that since investors in EM corporates are "generally not overleveraged and are more dominated by real money accounts," the asset class should hold up better in a tightening environment.'
The panel also agreed that the worst of the default cycle was in the past. Chan commented that weak issuers were “weeded out” in the 4Q of 2008 and 1Q of 2009. Miles added that “if the peak of the default cycle has not passed, there would be big problems with prices in the market.” Spegel concurred, noting that only $2 billion in EM corporate paper is priced at levels suggesting possible default.
As for the long-term effects of the crisis, Miles noted that post-crisis, there has been a pick-up in competition on the sell-side as more firms enter or come back to the business. Crossover and high-yield players are returning and the increase in dedicated real-money accounts has provided an anchor to an asset class which has proved its resilience. Chan and Kurdyavko commented that they had received more inquiries in recent months as more investors became convinced of the EM story.
The panel concluded with investor recommendations. Ivanchenko recommended Alfa, Gazprom and Russky Standart "for those with a bit of courage." He expressed greater skepticism for steel producers. 2010 will be a "wobbly" year in general, he advised.
Miles agreed that there is value in Russian corporates in the high-grade sector rather than high-yield. LatAm issues are "fairly priced" while Central American and Caribbean utilities are more attractive albeit less liquid. Kurdyavko preferred the bank, retail, and food-processing sectors and is cautiously optimistic on metals and mining. She recommended avoiding Chinese real estate ("equity risk for fixed income return" she argued)."
Chan saw value in Indonesian utilities and Mexican homebuilders. Spegel's own selections included Bertin, Globo and Brascan.