Emerging Markets

Investors Should Consider Corporate Emerging Market Debt – J Stern & Co

Tom Burroughes, Group Editor, London, 27 September 2022

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Investors, who might treat all emerging market debt as the same, are making a mistake. A European investment firm argues that they should also consider corporate EM debt as an attractive entry point.

Emerging market debt gets flak when investors think of defaults on sovereign bonds or sudden changes of government, but the field is much broader and contains opportunities that look attractive now, J Stern & Co, the European partnership has argued. In particular, the firm says corporate debt deserves attention.

And the firm, which has offices in Zurich, London and Malta, is so convinced of its case that it is planning to launch the Emerging Market Debt Stars Fund. The fund, which aims to generate a 5 to 6 per cent total return after fees over the medium term, focuses on corporate and quasi-sovereign issuers.

“I think there’s a lot of misconception about the asset class…and we are at a very attractive entry point and able to obtain a new source of income,” Jean-Yves Chereau, co-portfolio manager on the new fund, told journalists at a recent briefing.

As his colleague and co-portfolio manager Charles Gelinet said: “Whenever emerging market corporate debt is discussed, many investors associate it with emerging market sovereign debt. However, the risk/return profile of sovereign debt is very different to that of emerging market corporate debt.”

Investors in corporate EM debt are paid a higher yield for investing in companies based on the rating of the country they are based in, even if they are global firms with a diversified earnings stream, he said. 

In 2022, high inflation and tighter central bank monetary policy has hit major risk assets, but emerging market hard currency corporate debt has fallen less severely than most asset classes (-9.6 per cent), while the S&P 500 Index of US stocks has fallen 16.1 per cent and the MSCI World Index of developed countries’ stocks has fallen 17.5 per cent. On an annualised basis, returns, from 2002 to the present day, are more than 7 per cent for emerging market high-yield debt, with only US high-yield debt in front of all other fixed income categories, J Stern & Co data showed. The asset class has also posted relatively few down years (four out 21) over the 2002 to 2022 period. Strikingly, the firm said, US net leverage from corporate borrowers is higher than for emerging markets.

Concentration
The fund, which is available in a US dollar share class, requiring a minimum investment of $1 million, aims to hold between 30 to 50 issuers – making it a relatively concentrated portfolio – and only holds hard currency-denominated bonds among a mix of investment-grade and high-yield debt. Duration is relatively short: five-year maturities or less. J Stern & Co smiles on issuer sectors such as infrastructure, communications, and digital technology; energy transition sectors, and businesses that benefit from strong support from governments.

The philosophy governing the portfolio means that, for example, the portfolio is able to hold Argentina oil and gas company YPF, even though J Stern & Co holds no other Argentinian debt, because YPF has sufficient positive qualities to pass muster. Other examples of holdings include Alsea, a restaurant operator in Mexico, South America and Europe, and KOC Holdings, a Turkey-based conglomerate. The portfolio strategy does not hold assets in China or Russia. 

A reason for avoiding China is that “we just could not get comfortable with the visibility of the underlying businesses,” Gelinet told this publication when asked.

Chereau argued that the size of the emerging market corporate debt market is not very large, which can be a deterrent for large institutions, but is ideal for smaller players such as J Stern & Co and its clients.

This news service reported that J Stern & Co has opened an office in Malta, giving the business a continued foothold in the European Union, as the Mediterranean island is an EU member state.

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