Latin American corporates have become an attractive asset due to growth dynamics and shifts in the region’s economic structure, its valuation levels and diversification opportunities, as well as lower political and geographical risk in comparison to other emerging market (EM) regions.
It has the most to gain from a recovering US economy, and the recent tensions between Russia and the Ukraine – along with higher political risk in Turkey and scepticism over the Chinese economy – have all led many investors to increase their exposure to Latin American markets.
Emerging ahead of the pack
Deutsche Bank’s markets research goes on further to explain how this is exemplified by inflows into Latin American focused fixed income funds since the beginning of 2014, accelerating to 2.9 percent of total assets (see Fig. 1), which compares previously to outflows of 10.7 percent and 9.1 percent for Asia and Emerging Europe-focused funds, respectively. This trend has also been reflected in Latin American corporates that are strongly outperforming their peers from other EM regions since the beginning of 2014.
According to the widely followed JP Morgan CEMBI Broad Index, corporates in Latin America generated a total return of 6.03 percent year-to-date, facing 3.38 percent and -0.07 percent for the corresponding Asia and CEEMEA sub-indices. Volatile countries from Latin America – such as Argentina and Venezuela – have very little corporate bonds outstanding and are mostly viewed in isolation from rest of Latin America. But even a slight positive political change can lead to large upside potential on corporate credits from these countries.
Despite tapering the US Federal Reserve’s commitment to maintaining a low level of rate for a long time – and the ECB and Bank of Japan still being on the side of further unconventional stimulus – will keep the bid on higher yielding assets such as EM credits. As Latin American bonds overall have a higher duration than other EMs, they also benefit most from a contained yield level in the US treasury. Latin American credits have the highest amount of participation from US investors compared with other EM regions. For instance, JP Morgan data shows that 62 percent of the total new issuance volume from Latin American corporates in 2013 has been acquired by US Investors, compared to only 17 percent for new issues out of Asia and 30 percent out of emerging Europe and Africa.
Differentiating niche spreads
Spread levels of Latin American credits are much higher than US credits both in high yield and investment grade segments – providing further positive catalysts. According to Merrill Lynch, Latin American investment grade corporates on average provide a pick-up of around 125bps in spread compared to Northern American investment grade corporates from the US.
The spread difference increases further to around 250bps when looking at the higher yield segments. This is compared to a pick-up of around 60/300bps for Asia and 170/260bps for the Europe, Middle East and Africa region – the latter being reflective of the recent political tensions in Russia’s corporate space.
At the same time, Latin American corporate issuers offer robust credit and liquidity profiles. As of September last year, Merrill Lynch data has shown a comparable net leverage ratio of around 1.4 times for both Latin American and North American investment grade corporates from the US, while Latin American high yield issuers are showing significantly lower net leverages of around 2.9 times compared to four times for their US high yield counterparts.
Similarly, by looking at the respective liquidity ratios – as measured by cash relative to short-term debt – for both Latin American investment grade and high yield corporates (2.4 times and 1.6 times, respectively) relative to US corporates at 2.1 times and 1.5 times for the investment grade and high yield sub-segments. Taken together, this results in an attractive spread when adjusted by leverage of about 160bps for Latin America investment grade and 166bps for Latin America high yield issuers.
A great degree of diversity across issuer types is also of interest. According to further Merrill Lynch data, 30 percent of total new issuance volumes in 2013 can be attributed to the oil and gas sector; 17 percent to financials; 13 percent to the consumer space; and nine percent to telecommunication service providers, with the remainder being focused on the industrial and construction segments.
Latin America tends be a region with a low level of fiscal stimulus, leaving ample room for growth in the banking sector. Also, the financial sector tends to be a leading issuer in corporate bonds, and therefore the Latin American corporate bond markets a good place to be on the medium to long-term horizon.
