The Stern family has been an active investor in emerging markets for generations. In the nineteenth century, the family and its banks help to found important banks, many of which have prevailed until today, like Garanti Bank in Turkey or Banamex in Mexico. Meanwhile, Stern family banks in Paris, London and Frankfurt issued bonds in Europe for companies from many countries. In more recent times, J. Stern & Co. has developed its Emerging Market Debt strategy which seeks to preserve and create wealth by investing in hard currency bonds issued by quality emerging market businesses. It is an asset class that has traditionally been overlooked because investors’ perception of the risks it carries is greater than the actual risks.
This year is a case in point, where geopolitics, rising inflation, monetary tightening and recession concerns have impacted all risk assets. However, some have suffered more than others. Global equities are down 17.5% in US Dollar terms, US investment grade bonds are down 13.8%, whilst ‘hard currency’ emerging market corporate debt has fared better than most, down 9.6%.
Attractive entry point and unique source of income yield
The market repricing this year has led to higher yields in fixed-income assets. We believe this presents an attractive entry point for long-term investors to buy and hold bonds from companies with solid underlying fundamentals that deliver generous income and total returns at a time when the global outlook is uncertain.
Moreover, this level of yield fares favourably when compared to other asset classes: including equity dividend yield (average 2.0% over the last 10 years), US Treasury current yield (average 2.5%), and US corporate investment grade current yield (average 4.5%).
The overall emerging market debt asset class is worth around USD 26.3 trillion and spans multiple countries, thousands of issuers, and sectors. It has matured over the past two decades and is no longer a play on commodities but a broader and more diversified asset class. The asset class has two distinct categories – sovereign debt and corporate debt. We believe the latter, in hard currency (mainly US dollars), has a key role to play as a standalone asset class within a diversified portfolio or as part of investors’ wider strategy to generate an income from their portfolios.
The emerging market sovereign debt issued by governments accounts for the majority of the emerging debt universe (USD 13.6 trillion; of which USD 12.6 trillion equivalent is in local currency) and as such tends to attract the most attention from market observers. Erratic economic developments, political risks and foreign exchange volatility, which are more difficult to analyse, quantify and control, have all contributed to the high-risk image of the asset class.
However, ‘hard currency’ emerging market corporate debt whose risk profile is mostly driven by the companies’ fundamentals, suffers from its association with the emerging market sovereign debt asset class. As a result, emerging market corporate debt’s perceived risks are, in our view, greater than the actual risks associated with the underlying corporates as their financial and business strength more than offset the local risks.
A quality company with a strong and sustainable competitive position, generating predictable cash flow, is in a solid position to repay its debt, regardless of where it is located. However, a quality company based in a developed market would pay a yield considerably lower than if it were based in an emerging market because it is perceived as a lower risk. Investors in hard currency emerging market corporate debt are paid a premium for investing in companies based on the rating of the country they are based in, even if they are global companies with diversified sources of revenue and solid fundamentals
Hard currency emerging market corporate debt currently provides investors with a current yield of 5% and a yield to maturity of 7%. This is a higher yield than in March 2020 when the global pandemic was breaking out. Although there have been times when yields touched higher levels there is no doubt in our view that we are now in attractive value territory.