Emerging-Market Corporate Debt Set for Resurgence Amidst Decreasing Default Risks
The landscape of emerging-market corporate debt is on the brink of a significant revival as the risk of defaults diminish and confidence in a soft economic landing strengthens. This view comes from asset management firm Muzinich & Co., which highlights a turning point in the cycle of corporate defaults and downgrades across developing nations, setting the stage for renewed investor interest in sovereign and corporate debt portfolios within this asset class.
Warren Hyland, a seasoned portfolio manager at Muzinich & Co., overseeing $3.6 billion in emerging-market assets, suggests that the worst may be over for emerging-market corporates. “It’s almost like you’re entering into a market after the crash has happened,” Hyland remarked, pointing out the clearing of the deck with most susceptible entities already having faced defaults or downgrades. This clarity offers a foundation for potential growth in investment inflows.
Comparatively, the cycle of defaults in developed economies lags by approximately 12 to 18 months, indicating a unique window of opportunity in emerging markets. Hyland’s expertise, particularly demonstrated through the success of the $880-million Emerging Markets Short Duration Fund, which outperformed 90% of its competitors over five years, underscores the potential for strategic gains in this space.
Despite emerging-market debt funds experiencing $8.3 billion in outflows this year, an improvement from $15 billion in the preceding three months, according to data from EPFR compiled by JPMorgan Chase & Co., the mood is shifting. Last year’s total outflows amounted to $34 billion, but recent trends suggest an inflection point, bolstered by a downturn in corporate defaults.
Emerging-market corporates have defaulted on $8.2 billion of debt so far in 2024, showing a significant reduction from $15 billion during the same period in 2023 and $10 billion in 2022. This decline in defaults is paving the way for renewed investor confidence in the asset class.
One of the key trends influencing the emerging market corporate debt landscape is the shift towards domestic funding sources, especially in Asia, where borrowing costs remain relatively low compared to the US and Europe. This shift is partly due to the high-interest rates in these developed economies, encouraging companies to seek funding within their own borders. “We’ve seen that downdraft where onshore funding has replaced the offshore funding to a large extent,” Hyland explained, drawing on his two decades of experience in corporate credit and his leadership role in Muzinich’s Asian credit strategy.
In Latin America, a similar trend towards reduced reliance on dollar- or euro-denominated bonds is evident, driven by better liquidity in the banking system and high commodity prices, which diminish the region’s external funding needs. This realignment opens the door to new investment opportunities, particularly in countries less affected by the geopolitical tensions between Russia and Ukraine. Hyland highlights the potential in nations with similar trade compositions, such as Colombia, Brazil, the United Arab Emirates, and Saudi Arabia.
Recently, Muzinich & Co. adjusted its investment strategy, retracting its increased exposure to India in favor of opportunities in China due to more attractive valuations. “If there’s one area in the world where we can find good value still on the credit basis, it’s in China,” Hyland emphasized, pointing towards the enticing prospects in the Chinese credit market.
As emerging-market corporate debt enters a phase charmed with optimism and reduced default risks, global traders and investors are closely watching. This segment is becoming increasingly appealing for those seeking to diversively enhance their portfolios with potentially higher returns than those offered by developed market equivalents.
