Emerging-Market Debt
Insurance Insights
EMERGING-MARKET DEBT: FUNDAMENTALLY ATTRACTIVE Emerging-market debt can offer compelling opportunities for investors seeking higher levels of income alongside credit quality stability
Over the last five years, emerging markets and investors have VALUATIONS: TIGHTER BUT STILL A PICKUP been locked in a love/hate relationship. On the one hand, there Europe-based insurance companies have tended to focus on have been periods when investors have been keen to venture hard-currency–denominated EMD as an alternative to their US beyond their natural habitats and move into emerging-market debt dollar– and/or euro-denominated DM corporate bond allocations. (EMD) in search of more attractive yields than they can access in The Solvency II framework outlines similar capital charges for most developed markets. And, on the other hand, there have been hard-currency–denominated securities with comparable ratings times when appetite for EMD has soured as emerging markets and maturities, whether the issuers are in developed or emerging have been rocked by outbreaks of volatility. Some of the more markets. This means that EMD tends to offer a higher return on tempestuous episodes were triggered by the US Federal Reserve’s capital than DM bonds. Compared with US credit, for example, EM announcement in 2013 that it planned to tighten monetary policy, corporate debt currently offers a yield uplift of around 40 basis by worries about growth in China in 2015 and, most recently, by points (b.p.) for similar credit quality. In addition, the diversification uncertainties about how US President Donald Trump’s policy benefits accrued from EMD allocations could help insurers reap agenda might affect emerging-market (EM) countries. additional capital efficiency gains under Solvency II.
Getting market timing right is particularly critical for insurance investors. They’re under pressure to invest new inflows from their DISPLAY 1: EM IG CORPORATE VS. US IG CORPORATE clients promptly. But they’re also keenly aware of the potential pitfalls involved in rushing to invest at a time when valuations 350 400 across asset classes and across geographic markets look richer than they have for a while. EMD has seen strong inflows (and 300 generated strong returns) throughout 2016 and in the first quarter 300 Spread Di erence (b.p.) 250 of this year. Does this mean insurance investors still sitting on the sidelines have waited too long to reap EMD’s upside potential? 200 200 From a valuation-only perspective, we think EMD is trading at 150 Spread (b.p.) fair levels compared to similarly rated developed-market (DM) 100 100 investments. But we also think investors should recognize that the asset class is poised to benefit from highly supportive 50 improvements in its underlying credit fundamentals—as well as 0 0 from positive technical factors. We think this means EMD can still 09 10 11 12 13 14 15 16 17 offer compelling opportunities for investors seeking higher levels l EM IG (Adjusted) l US IG l Di erence (Right Scale) of income alongside credit quality stability.
Historical analysis is for illustrative purpose only. Through 31 March 2017 Source: Bank of America Merrill Lynch and AB
EMERGING-MARKET DEBT: FUNDAMENTALLY ATTRACTIVE 1 DISPLAY 2: RATINGS MIGRATION OF INDICES
A
A–
BBB+
BBB
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 l EM IG Corporate l US IG Corporate l EM IG (Corporate and Sovereign)
Historical analysis is for illustrative purpose only. Through 30 September 2016 Source: BofA Merrill Lynch and AB
Historically, the EMD yield uplift has oscillated somewhere As a result, many EM economies have grown less reliant on foreign between 30 b.p. and 90 b.p., averaging around 55 b.p. over the capital—and, therefore, less vulnerable to potential investment last five years. The current 40 b.p. pickup is on the tight side. But outflows as interest rates in developed markets continue on their this reflects an improving credit story—over the last decade, the upward trajectory. In fact, we think a gradual rise in developed- average credit quality of EM investment-grade (IG) bonds and US market rates as global growth firms could actually prove good news IG corporate bonds has converged to an unprecedented extent. for emerging markets, as it’s likely to be accompanied by stronger The IG playing field today has more EM issuers—both companies global economic activity and commodity prices. and countries—than ever before, with Colombia, Peru and the Philippines among the sovereigns that have now gained IG status. With inflationary pressures under control and external balances improving, many EM countries have been hard at work reining EM FUNDAMENTALS STRONGER in their fiscal imbalances. This has involved overhauling tax As global growth rates firm, many EM economies are seeing structures, restricting government spending, and reforming their growth rates accelerate. In particular, many EM commodity pensions and other social expenditure programs. exporters have benefited from the stabilization in commodity prices. We expect global growth of 2.8% in 2017, up from 2.4% Brazil, for example, has approved austerity measures that include last year, with EM economies powering ahead of the developed a cap on public spending to help control the country’s burgeoning world and growing by 4.1% compared with developed markets’ budget deficit. Colombia has passed significant tax reform, which 2.1% growth. should stimulate investment and growth. And it’s taken steps to crack down on tax evasion and improve tax collection. India is At the same time, declining or stable inflation rates in most on track to implement a goods-and-services tax to replace local major emerging markets should allow these countries to follow levies, which should make it easier to do business in the country. looser monetary policies, which, in turn, should help bolster their Other countries, including Indonesia and Mexico, are cutting growth prospects. back fuel subsidies as part of promarket efforts to reform their economies. Collectively, these moves are helping to establish Meanwhile, traditional concerns about the higher risks of investing firm foundations for long-term, sustainable economic growth, in more potentially volatile EM economies and companies have bolstering the credit quality of several EM countries. been receding as investors have seen signs of positive structural change in the developing world. Many EM economies have The EMD asset class is also underpinned by supportive technicals. significantly improved their current account balances—the Flows into EMD turned positive in 2016 after years of outflows, difference between what a country exports to the rest of the world while, overall, net issuance levels remain modest. At the same and what the rest of the world exports to that country. time, the investable EMD universe has steadily grown deeper and broader. It now represents a US$2.7 trillion opportunity set.
2 DISPLAY 3: EMERGING-MARKET DEBT UNIVERSE
ta terna e t ereign r rate an uasi ereign i i n i i n i i n
41 4 3 1
l igh ie an l In est ent ra e
As of 31 December 2016 Source: Bloomberg, Bond Radar and J.P. Morgan
BUILDING EMD ALLOCATIONS Every insurer will have a different investment objective when DISPLAY 4: EM AND G4 REAL RATES, DIFFERENTIALS allocating to the debt of EM countries and companies. Though it was once seen as a niche opportunity that could be used 6 opportunistically as a diversifier, more are starting to view 5 EMD as a core strategic allocation that lies at the heart of their 4 efforts to secure stable investment income over multiyear Forecast investment horizons. 3
In the Solvency II context, insurers with a focus on stable income 2 generation and credit quality may prefer to focus exclusively on Percent 1 hard currency and IG-only EMD. As the charts above show, this is a sizeable US$1.6 trillion universe for insurers to tap into. 0
Given current market dynamics, we think that smaller, more tactical (1) allocations to local-currency debt and high-yield EMD could also 09 10 11 12 13 14 15 16 17 prove rewarding from a total return perspective, even though such l EM l G4 l EM–G4 allocations imply higher capital charges. Historical analysis is for illustrative purpose only. The shift toward tighter fiscal policies has helped to boost As of 31 March 2017 currency values in many EM countries, and we see room for Source: Bloomberg and AB further appreciation in selected currencies, provided governments continue to tighten their belts. We think that could enhance the attractions of local-currency–denominated EMD in particular. Overall, then, as long as EM fundamentals continue to improve, and Along with appealing currency valuations, these securities offer DM interest rates remain relatively low, we see a strong case for real—or inflation-adjusted—yields that are significantly higher than Europe-based insurance investors to look beyond the tribulations are those available on high-grade DM government debt. And real of the past and to focus on the potential that EMD could offer. interest-rate differentials between emerging and developed bonds are hovering near record highs.
EMERGING-MARKET DEBT: FUNDAMENTALLY ATTRACTIVE 3 LEARN MORE [email protected] | ABGLOBAL.COM
NOTE TO ALL READERS: The information contained here reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed here may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AB or its affiliates. Note to Canadian Readers: This publication has been provided by AllianceBernstein Canada, Inc. or Sanford C. Bernstein & Co., LLC and is for general information purposes only. It should not be construed as advice as to the investing in or the buying or selling of securities, or as an activity in furtherance of a trade in securities. Neither AllianceBernstein Institutional Investments nor AllianceBernstein L.P. provides investment advice or deals in securities in Canada. Note to European Readers: This information is issued by AllianceBernstein Limited, a company registered in England under company number 2551144. AllianceBernstein Limited is authorised and regulated in the UK by the Financial Conduct Authority (FCA–Reference Number 147956). Note to Swiss Readers: This document is issued by AllianceBernstein Schweiz AG, Zürich, a company registered in Switzerland under company number CHE-306.220.501. AllianceBernstein Schweiz AG is authorised and regulated in Switzerland by the Swiss Financial Market Supervisory Authority (FINMA) as a distributor of collective investment schemes. Note to Readers in Japan: This document has been provided by AllianceBernstein Japan Ltd. AllianceBernstein Japan Ltd. is a registered investment-management company (registration number: Kanto Local Financial Bureau no. 303). It is also a member of the Japan Investment Advisers Association; the Investment Trusts Association, Japan; the Japan Securities Dealers Association; and the Type II Financial Instruments Firms Association. The product/service may not be offered or sold in Japan; this document is not made to solicit investment. Note to Australian Readers: This document has been issued by AllianceBernstein Australia Limited (ABN 53 095 022 718 and AFSL 230698). The information in this document is intended only for persons who qualify as “wholesale clients,” as defined in the Corporations Act 2001 (Cth of Australia), and should not be construed as advice. Note to Hong Kong Readers: This document is issued in Hong Kong by AllianceBernstein Hong Kong Limited (聯博香港有限公司), a licensed entity regulated by the Hong Kong Securities and Futures Commission. This document has not been reviewed by the Hong Kong Securities and Futures Commission. Note to Readers in Vietnam, the Philippines, Brunei, Thailand, Indonesia, China, Taiwan and India: This document is provided solely for the informational purposes and is not investment advice, nor is it intended to be an offer or solicitation, and does not pertain to the specific investment objectives, financial situation or particular needs of any person to whom it is sent. This document is not an advertisement. AB is not licensed to, and does not purport to, conduct any business or offer any services in any of the above countries. Note to Readers in Malaysia: Nothing in this document should be construed as an invitation or offer to subscribe to or purchase any securities, nor is it an offering of fund-management services, advice, analysis or a report concerning securities. AB is not licensed to, and does not purport to, conduct any business or offer any services in Malaysia. Without prejudice to the generality of the foregoing, AB does not hold a capital-markets services license under the Capital Markets & Services Act 2007 of Malaysia, and does not, nor does it purport to, deal in securities, trade in futures contracts, manage funds, offer corporate finance or investment advice, or provide financial-planning services in Malaysia. Note to Singapore Readers: This document has been issued by AllianceBernstein (Singapore) Ltd. (“ABSL”, Company Registration No. 199703364C). ABSL is a holder of a Capital Markets Services Licence issued by the Monetary Authority of Singapore to conduct regulated activity in fund management and dealing in securities. AllianceBernstein (Luxembourg) S.à r.l. is the management company of the portfolio and has appointed ABSL as its agent for service of process and as its Singapore representative. This document has not been reviewed by the MAS.
MARKET RISK: The market values of the portfolio’s holdings rise and fall from day to day, so investments may lose value. Interest-Rate Risk: Fixed-income securities may lose value if interest rates rise or fall—long-term securities tend to rise and fall more than short-term securities. The values of mortgage-related and asset-backed securities are particularly sensitive to changes in interest rates due to prepayment risk. Credit Risk: A bond’s credit rating reflects the issuer’s ability to make timely payments of interest or principal—the lower the rating, the higher the risk of default. If the issuer’s financial strength deteriorates, the issuer’s rating may be lowered and the bond’s value may decline. Inflation Risk: Prices for goods and services tend to rise over time, which may erode the purchasing power of investments. Foreign (Non-US) Risk: Investing in non-US securities may be more volatile because of political, regulatory, market and economic uncertainties associated with such securities. These risks are magnified in securities of emerging or developing markets.Currency Risk: If a non-US security’s trading currency weakens versus the US dollar, its value may be negatively affected when translated back into US dollar terms. Diversification Risk: Portfolios that hold a smaller number of securities may be more volatile than more diversified portfolios, since gains or losses from each security will have a greater impact on the portfolio’s overall value.Derivatives Risk: Investing in derivative instruments such as options, futures, forwards or swaps can be riskier than traditional investments, and may be more volatile, especially in a down market. Leverage Risk: Trying to enhance investment returns by borrowing money or using other leverage tools may magnify both gains and losses, resulting in greater volatility. Below- Investment-Grade Risk: Investments in fixed-income securities with lower ratings (commonly known as “junk bonds”) tend to have a higher probability that an issuer will default or fail to meet its payment obligations. Liquidity Risk: The difficulty of purchasing or selling a security at an advantageous time or price. AllianceBernstein Investments, Inc. (ABI) is the distributor of the AllianceBernstein family of mutual funds. ABI is a member of FINRA and is an affiliate of AllianceBernstein L.P., the manager of the funds. The [A/B] logo is a registered service mark of AllianceBernstein and AllianceBernstein® is a registered service mark used by permission of the owner, AllianceBernstein L.P. © 2017 AllianceBernstein L.P.
17-XXXXXXXXXXX GI–7551–0517