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Corporate Bond Forum - January 25, 2011

Attendance at EM Corporate Bond Conference Suggests Interest in Asset Class Remains at High Levels

Attendance at EMTA’s Corporate Bond Forum in London, held on Tuesday, January 25, 2011, hit a new record with market professionals spilling out from the main auditorium into several adjoining rooms. ING hosted the event, which suggested interest in the EM corporate arena remains strong.

David Spegel, ING’s Global Head of EM Strategy, moderated the event’s panel discussion. Spegel polled panelists for their views on current pricing levels, as well as their expectations on inflows. Polina Kurdyavko (BlueBay Asset Management) still saw value in the asset class from both a technical and fundamental stance. “It is probably the best return you are going to see in the fixed income space—a BBB average-rated asset, with potentially a seven percent return--and that is in addition to the diversification argument,” she stated. In contrast, Kurdyavko believed developed country corporates would return two to four percent, and US high yield six to nine percent (the latter of which has twice the volatility of EM, she underscored). JPMorgan’s Warren Mar agreed noting, however, that the JPM CEMBI index is only 5-10 bps wide of his firm’s official year-end forecast, and that 2011 performance would depend much more on asset selection rather than general market moves.

Esther Chan (Aberdeen Asset Management) argued that fundamentals and debt servicing abilities support current EM corporate pricing. However, she continued, “We think that it is important to be selective on credits, understand the credit risks and be disciplined about pricing those risks.”

Would corporates still receive the lion’s share of EM inflows? “Looking at the fact that today’s conference is so wildly overbooked, it is obvious that there is still a lot of interest in EM corporates,” observed Mar. He added that the sell-side firm analysts continue to “hit the road” to meet potential investors. While retail has dominated recent inflows, crossover and institutional money would likely comprise a large portion of future new money.

VTB Capital’s Nikolay Podguzov stressed that high growth rates in EM economies generally continue to support the asset class. He believed that moderate spread tightening would continue, with increasing focus on second-tier bonds.

Several speakers expressed concern that protectionism might be a risk. As for commodity price risk, Chan reminded participants that, while a sharp spike in oil pricing could have harmful effects to importing sovereigns, some corporates (e.g. those in Russia) could actually benefit. She predicted 2011 would prove a volatile year. Mar noted that the benign credit environment had allowed for easy refinancing, while cautioning that this could change and cause refinancing concerns. Kurdyavko remarked that she had noticed Street research not pricing in a Eurozone default, which the market appears to be assuming a “muddle through” scenario, and this might not be the case.

Discussing potential restructurings, Kurdyavko noted that recent restructurings have been more investor-friendly, aided by new bankruptcy laws. “I am impressed with the speed of deals and recovery rates; haircuts have not been as punitive as one could expect,” she stated. She reminded investors that, in some defaults, EM bondholders could be not as well positioned as their developed market counterparts, specifically citing the better treatment of shareholders under Mexican bankruptcy laws compared to Chapter 11 filing. Mar added that recent restructurings have moved quickly as shareholders had incentives to get deals done and avoid going through the courts.

Podguzov pointed out that, unlike the recent developments in Latin America, Russian laws do little to protect bondholders. He and Kurdyavko agreed that recoveries in local Russian corporate defaults could be five cents on the dollar, and suggested that investors look elsewhere.

On issuance, panelists concurred that the amount of new paper entering the market was likely to remain at high levels. Chan commented that even firms that have been repeat defaulters in the past decade have attempted to tap the market again. Mar observed that already $30 billion in corporate paper has been issued vs. a JPM full-year forecast of US$166 billion. “Asian retail provided key support for deals in 2010; we could potentially lose some of that to Asian equities in 2011,” he commented.

Kurdyavko expressed concern that “there are too many deals compared to the number of dedicated analysts covering the EM corporate space,” with at least one-third of new deals from new issuers. Both she and Chan stressed the importance of bond covenants (Kurdyavko acknowledging she speaks on them each year at the EMTA event), and also advised investors to look at the structure of the bonds.

Spegel also solicited feedback on the nascent “dim sum” market. Chan offered that the recent issuance in CNH bonds, “while interesting is essentially an RMB trade, which could face liquidity issues and the lack of a backstop bid when sentiment towards the RMB turns around.”

Before adjourning to a cocktail reception, Spegel requested the speakers’ investment recommendations. Podguzov favored Russian second-tier metal and mining issues. Chan would “play the range” on some Chinese property firms, would buy some upcoming Philippine deals “at the right price,” but would avoid Latin airlines.

Mar commented that 2011 will be more a year of "carry" with the focus for outperformance around HY and event-driven situations such as Dubai Holdings, BTAS, and Bakrie Telkom. He said that the rally in EM had left investment-grade debt looking relatively expensive and that JPMorgan had recently moved to an underweight recommendation in a number of Asian investment-grade corporates. Kurdyavko viewed telephone and mining companies key overweights, with banks (on a technical basis) and real estate underweights. Sberbank was on Spegel’s recommended list.