The first five weeks of 2024 have seen a notable trend among emerging-market traders: corporate bonds denominated in US dollars are delivering higher returns than most other asset classes within the EM universe. According to data from Bloomberg, these bonds are generating annualized gains of 12% in US currency terms, outperforming US corporate notes and narrowing the yield spread to its lowest point since June 2021.
The surge in prices can be attributed to a scarcity of EM corporate bonds in secondary trading, with fewer issuances than anticipated. In contrast, sovereign bond sales experienced the most active January in three years. Companies, facing moderate refinancing needs and alternative fundraising avenues like local-currency debt, are under less pressure to raise dollar debt. Some companies are even returning capital to bondholders through debt buybacks.
Simon Cooke, a money manager at Insight Investment in London, noted, “Much better starting valuations when compared to US corporates, lower supply than expected, a series of buybacks and tenders, and a supportive macro backdrop have combined to push emerging-market corporate bonds to the top of the leader board.”
The Bloomberg EM USD Aggregate Corporate Index has extended its rally for a third consecutive month, reducing its average yield by 14 basis points in January. Despite the volatility in emerging markets that erased $1.6 trillion of shareholder wealth, the yield spread between emerging-market corporate bonds and the Bloomberg US Corporate Total Return Index has fallen to 174 basis points, the lowest since mid-2021. Investors find this gap attractive, offering a yield pickup of 270 basis points over Treasuries.
Interestingly, bonds abandoned by investors in the past two years are making a comeback. First Quantum Minerals Ltd.’s securities, mining in Zambia and Panama, are among the best performers in their peer group, with the 2031 note returning over 11% this year. Ukrainian companies, including poultry giant MHP SE and steelmaker Metinvest BV, are leading the Bloomberg corporate bond index with extended rallies.
Sergey Dergachev, head of emerging-market corporate debt at Union Investment Privatfonds GmbH in Frankfurt, commented, “There are some interesting pockets of value. The bonds offer great diversification in terms of country and sector exposure, but country and company-specific analysis matters.”
While governments in developing nations rushed to sell bonds in early 2024 amid uncertainty, corporate sales were relatively muted. Companies sold $39 billion in new debt in January, up from $29 billion in the prior-year period, but significantly less than the $73 billion raised in January 2020. Dergachev highlighted, “EM corporate supply is slowly picking up, but it still lags EM sovereigns.”
Several countries are working on developing local-currency bond markets to enable companies to borrow in their own currency. Investors are increasingly drawn to this asset class due to rate cuts and bets on a weaker US dollar.
Despite companies having to repay $378 billion of dollar bonds in 2024, the smallest maturity wall since 2017, companies’ cash balances have risen. Members of the MSCI Emerging Markets Index posted a 4.2% increase in free cash flow in 2023, with expectations of a 4.6% increase in 2024. Consensus estimates suggest firms will grow operating-profit margins to 14.2% in 2024, up from 11.7% in 2023.
Economists forecast accelerated growth, with an average 4.1% increase in gross domestic product in 2024 and 4.2% in 2025. This optimism for corporate earnings is reflected in analyst estimates for MSCI index companies, which have risen by 5% in the past five months. For the bond market, faster economic growth, higher earnings, and better margins indicate a trend of less need for fresh borrowing. Sergey Dergachev concluded, “I do expect that in 2024, we will witness negative net supply, which is positive for markets.”
