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Obstacles Make Way for Opportunities in Emerging Markets

Gerhardt (Gary) P. Herbert, CFA   |   Bonds   |   Credit Markets   |   Macro Trends   |   Outlook   |  Download PDFDownload PDF
We believe emerging market opportunities in credit markets are finally becoming more evident. Returns on equity have collapsed over the last several years, and debt relative to earnings before interest, taxes, depreciation, and amortization (EBITDA) appears to have peaked as operating margins have diminished and leverage has ceased to increase (see Chart 1). The focus now is on balance sheet management and earnings stabilization—an environment typically positive for credit investors.

Most major emerging markets—with the exception of those that generate U.S. dollar (USD)-based revenue—have issued their debt in local currency, avoiding the currency mismatch which caused so many challenges historically (see Chart 2).

Current conditions point to opportunities in USD-denominated emerging market corporate and sovereign debt. Furthermore, local currency debt may also offer attractive prospects in developing markets that are most compelling due to currency adjustments.

After monitoring emerging market credit markets for some time, we recently began buying select quasi-sovereign and corporate bonds in certain Latin American (Latam) countries. Latam investment grade yields, from a relative valuation standpoint, currently are nearly double U.S. investment grade (see Chart 3), an attractive entry point on a historical basis. Latam high yield also compares favorably to U.S. high yield (see Chart 4).

Credit ratings for emerging markets as a whole have also bottomed (see Chart 5), signaling, in our opinion, a potential turnaround. More specifically, emerging market corporate and sovereign rating downgrades reached their zenith in late 2015 into early 2016 and have since pulled back (see Charts 6 and 7).


The rout in commodity prices, particularly for oil, has been another obstacle for commodity-linked emerging markets that is now showing signs of improvement. Recent oil price stability—prices above USD $35 per barrel—should lend further support for emerging market opportunities. With commodity prices, spread valuations, and credit ratings stability currently in better alignment, we anticipate that opportunities in hard currency emerging market corporates are now appropriate.

Groupthink is bad, especially at investment management firms. Brandywine Global therefore takes special care to ensure our corporate culture and investment processes support the articulation of diverse viewpoints. This blog is no different. The opinions expressed by our bloggers may sometimes challenge active positioning within one or more of our strategies. Each blogger represents one market view amongst many expressed at Brandywine Global. Although individual opinions will differ, our investment process and macro outlook will remain driven by a team approach.