The shock to the world economy caused by the covid-19 pandemic has resulted in a drastic re-pricing of all risk assets and emerging markets corporate high yield debt is no exception.
However, while it is never a pleasant experience for investors to see an asset suffer double-digit falls in a matter of weeks, at times like this it is vital that the rational investor keeps a level head and resists the urge to panic, writes Dimitry Griko, chief investment officer at EG Capital Advisors.
Whenever the market plummets, the classic response of the inexperienced investor is to attempt to withdraw their money until the trouble blows over, which is often the worst course of action they can possibly take.
A more constructive approach is to take a step back, try to ignore the short-term volatility and negative newsflow and focus instead on fundamentals.
When you do this, a more positive picture of emerging market high yield debt emerges.
Going the distance
While nobody knows how long the crisis will last, current valuations in the corporate high yield space are extremely attractive and provide unprecedented opportunities.
Until the covid-19 infections are under control, we have to expect increased volatility in the market and any assumptions on the short-term direction of the markets would only be guesswork.
What we can do, however, is concentrate on the long-term value that is currently being presented to us.
It is not uncommon to find yields of more than 15%, by which the market implies default rates of more than 25% a year.
In comparison, emerging market high yield defaults stood at 5.5% in the 2008/2009 financial crisis while US high yield defaults hit 11.8% – and these were single-year spikes.
The fact that so many securities are now trading at close to recovery values means the potential upside in the sector is far greater than the downside.
In addition, the indiscriminate nature of the sell-off, with all correlations going to one, means that many bonds have been dumped regardless of the underlying credit quality.
In such a scenario it is possible to further balance the risk/reward trade-off in your favour.
Not a smooth ride
Of course, it will be not be all plain sailing for emerging market high yield debt going forward.
The long-term fundamentals look compelling, but in the short-term, asset prices are dependent on fund flows and volatility remains high.
While fund managers are seeing plenty of opportunity in this part of the market, they have become forced sellers as their end investors have pulled their cash.
Although it looks like the first wave of redemptions has come to an end, it is difficult to gauge whether we will see a second wave – for example if investors seek more liquidity, or if panic over the virus ramps up, in the event of a spike in infection rates in the US.
We might not know when the turnaround will happen, but we do know that it will happen as the virus pandemic cycle is finite.
And, while governments and central banks are doing everything that they can in terms of providing various stimulus packages and injecting liquidity into the markets, this will not re-launch the global economy until people are allowed to leave their homes and return to their normal way of life.
The imminent effect of these actions on the global economy can be questionable, but they will provide a very significant boost on the rebound.
A key difference
The beauty of emerging market high yield debt is that we do not need to guess when this moment will be.
Instead, all we have to do is hold the credit of companies that we are confident will survive this crisis.
The rebound, when it comes, will be significant, supported by a wall of cheap money and a mountain of delayed demand that is currently being accumulated.
This is why, rather than being worried, I am actually excited: with the market pricing in levels of defaults that were not realised in any of the previous crises, we are being well paid to take on risk.
From a buyer’s point of view, emerging market high yield debt hasn’t looked this attractive for many years.
Opportunities to buy in at such low levels only crop up a couple of times in your life, and when they arise, you need to grab them with an appropriate allocation.
Sitting in cash and missing this opportunity should be an even scarier prospect for the long-term investor than this year’s crash.
This article was written for Expert Investor by Dimitry Griko, chief investment officer at EG Capital Advisors.
