The Growing Opportunity set for Emerging Markets Credit
The Emerging Markets credit offers a huge opportunity set, with the Emerging Markets tradeable debt stock growing 15% annually from 2000 to 2020. We asked Sandglass Capital Management, a hedge fund focused on investments in Distressed, Dislocations, and Deep Value across the Emerging Markets and the frontier world to walk us through that opportunity set.
Emerging Markets foreign currency debt universe has doubled since 2008 and now exceeds $4 trillion, while domestic debt outstanding is getting close to $25 trillion. The universe of Emerging Markets credit assets continues to grow across both external corporate and local currency credit assets. And yet most institutional portfolios are under-allocated to Emerging Markets credit despite the asset class having a higher sharpe ratio than even US treasuries and weak correlation to beta factors. Emerging Markets Credit assets broadly exhibit low correlation, relatively low (portfolio) volatility, and robust returns.
Emerging Markets High Yield total notional outstanding is larger than US High Yield markets
Recent BAML report includes a long-term cross-asset study and concludes that Emerging Markets credit is an attractive, high sharpe ratio asset class, and yet is grossly under-represented in institutional portfolios.
Distressed Credit Dynamics
1. Periods of USD strength often trigger Emerging Markets distressed and stressed credit opportunities.
2. Emerging Markets distressed debt universe exploding driven by:
Rapid and massive foreign currency debt built up over the past 10-15 years.
The unprecedented economic crisis leading to a substantial plunge in corporate revenues (to a large extent explained by lower commodity prices).
Sharp Emerging Markets FX devaluation
3. Emerging Markets distressed credit opportunities likely to continue growing. At this writing, there is over $300 bn in distressed indexed bonds outstanding and an even larger opportunity set in off-index bonds.
4. Stressed and distressed credit is highly inefficient with few participants, but recovery prospects are no worse than in developed markets:
Most Emerging Markets credit managers do not have the mandate to hold an asset through restructuring.
A handful of dedicated managers globally in the space means that entry prices are often well below reasonable recovery value.
Bank proprietary trading desks were the buyers pre-2008, and are no longer in the market.
Issuers have strong incentives to restructure and get back to markets to take advantage of favorable rates environment.
5. Emerging Markets distressed credit, despite its equity-like features, has dramatically outperformed other asset classes in the last cycle (from 2010 – 2020).
The best performing tradeable Emerging Markets asset class.
Substantially overlooked by investors.
6. Pricing in loans versus bonds typically offers a substantial excess return for similar credit metrics, thus rewarding patient investors who can take some illiquidity and a longer-term view.
7. Strong liquidity premium for less liquid assets: higher upside/downside features, credit coverage, yields.
8. Stressed / distressed loans further benefit from an even more limited audience of prospective buyers.
Special Thanks to our Contributor:
Sandglass Capital Advisors, LLC
27 West 24th Street, Suite 805
New York, NY 10010
Telephone: +1 (646) 780-1100
Sandglass Capital Management focuses on investments in Distressed, Dislocations, and Deep Value across the Emerging Markets and frontier world. Sandglass founders believe that the space represents an Alpha rich universe of potential investment opportunities with significant convexity of returns and limited correlation to global market factors. Asset prices in emerging markets are prone to frequent dislocations and mispricings that can create asymmetric return opportunities for diligent investors.