EM Corporate Debt: An Underappreciated Opportunity for Insurers? :: Insurance Asset Risk

Elisabeth Colleran, CFA, Portfolio Manager

As global trade dynamics shift under the influence of US trade protectionism, many investors see this as a pivotal moment to reassess their portfolio exposures. While home-country bias might lead US investors to focus inward, we believe the evolving balance of risks and growth prospects outside the US presents compelling opportunities, particularly in emerging markets (EM) corporate bonds.

In this Q&A, Elisabeth Colleran, CFA, Portfolio Manager of Loomis Sayles’ Emerging Market Debt Strategy, explores the implications of tariffs on EM economies and discusses how the broader EM landscape offers potential for diverse sources of growth, resilience and adaptability in the face of trade disruptions. As EM and developed market growth differentials shift, Elisabeth believes investors may benefit from exploring the underappreciated potential within EM economies, which are increasingly integral to the global economic fabric.

1) How did spreads perform during the April market turbulence?

EM corporate credit was resilient through the tariff shock. People tend to expect big moves out of EM, but spread widening in EM was orderly and in line with US corporate credit. In April, the JP Morgan CEMBI Broad Diversified Index widened by +29 basis points, with the IG segment wider +20 basis points and the HY segment +41 basis points. US IG corporates and US HY widened by +12 basis points and +37 basis points, respectively.¹ This is not an EM-centric crisis in our view; we see US companies as the most exposed to the first-order impact of tariffs, while EM corporates are more insulated.

2) Many investors foresee lower global growth and increased market volatility ahead. How do you see EM assets faring under those conditions?

With uncertainty dominating today’s markets, we believe diversification beyond developed markets is warranted. The EM corporate debt universe offers exposure to more than 60 countries, many with domestically oriented economies, and a geographically diverse buyer base. In aggregate, EM countries are growing at more than twice the rate of developed markets. Key underpinnings of the asset class remain in place: yields for the EM corporate universe remain well above the ten-year average and EM corporate debt fundamentals continue to show better metrics than both the US and European corporate spaces. From a ratings perspective, EM has been in the midst of an upgrade cycle. Inflation has generally fallen below the midpoint of target ranges and many central banks have lowered their inflation targets.

We believe EM sovereigns, for the most part, are in a good place. In many EM countries, particularly in Asia, growth is starting from a higher level than in the developed market. We expect the EM-DM growth differential to be largely unchanged at 2.3% or even slant more toward EM, should the US move toward recession.

Both EM and developed market countries continue to face fiscal pressures, but in our assessment, EM has buffers with monetary bandwidth to support growth. In most core EM countries, real rates remain high. The weakening US dollar and, to some extent, capital flows offer central banks cover to pursue policy rate cuts without an outsized currency reaction, in our view. We see very low oil prices as a tailwind for much of EM, which can positively impact current account deficits, growth and/or inflation. Exporters may also see support from elevated prices for gold and (to a lesser degree) copper.

Underlying rates volatility has been elevated given the uncertainty over the path of US inflation and the Federal Reserve’s reaction function. The Fed is likely to cut if US growth slows, but near term the shape of the yield curve remains in flux as markets seek to price in uncertainty and absorb a variety of technical factors. In contrast, core EM countries are benefiting from central banks that are cutting rates (moving well ahead of the Fed and European Central Bank) with a focus on internal inflation and growth dynamics.

3) What risks and opportunities do you anticipate for EM economies as US trade protectionism takes root?

We see Asia as the region most vulnerable to US trade protection given its large manufacturing base, yet core emerging Asia countries are among the fastest-growing economies globally. China is in a unique position given the magnitude of the announced tariffs and also the country’s size, complexity and importance to the global economy, and we expect trade tensions to remain elevated between the US and China. Some recent Street estimates suggest the trade war could drag down Chinese growth by about 1%. In the face of these headwinds, we see Chinese policymakers acting aggressively to support domestic demand. China is likely to continue to implement near-term countercyclical measures, including front-loading economic stimulus, expanding fiscal deficits and implementing additional interest rate cuts to support growth.

Outside of China, we expect core EM Asia countries facing reciprocal tariffs to come to the negotiating table. We also see EM Asia ex-China benefiting from lower oil prices and room to address growth headwinds with monetary and fiscal policy. In our view, countries with more domestic-focused economies such as India and Indonesia will face lower growth headwinds, while large technology hubs such as South Korea and Singapore may face greater hurdles.

Many core EM countries in Africa, EM Europe, Latin America and the Middle East are insulated from the first-order impact of tariffs. Most of these core countries are subject to the lower 10% baseline, have more domestically focused economies, trade more with Europe than with the US, or export hydrocarbons/minerals that remain exempt from tariffs.

Overall, we believe the reorientation of supply chains and the reconfiguration of trade may present opportunities for some EM countries, while presenting headwinds for others. For example, we have little doubt that agriculture in Latin America will benefit as China pulls back from US supply.

Another interesting observation is that we have seen trade among EM economies surge over the past 20 years. As a percentage of global goods traded, trade among EMs has almost doubled to around 30% while trade between EM and developed markets has dropped by 5 percentage points. The reconfiguration of global trade may encourage this trend.²

Endnotes:
1 Sources: JP Morgan CEMBI Broad Diversified Index (EM figures); Bloomberg US Corporate IG Index and Bloomberg US Corporate HY Index (US figures).
2 Sources: Centre d’Études Prospectives et d’Informations Internationales (CEPII), International Trade Center.

Disclosure

This marketing communication is provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted and actual results will be different. Data and analysis do not represent the actual or expected future performance of any investment product. Information, including that obtained from outside sources, is believed to be correct, but Loomis Sayles cannot guarantee its accuracy. This information is subject to change at any time without notice.

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