Fixed Income Opportunities In a Deleveraged Banking Environment - - PowerPoint PPT Presentation

Fixed Income Opportunities In a Deleveraged Banking Environment Emerging Markets Private Debt

Adrian Petreanu - Portfolio Manager Ashmore Investment Management Limited March 2014

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• As a whole, Corporate Debt has assumed a much greater stake in

Emerging Markets debt: from 2011 to 2013; Corporate Debt grew roughly 10% to US$6.75trn and is approaching US$7.77trn1

• Emerging Markets Corporate Debt is the fastest growing asset class

in Emerging Markets for the last 5 years

• Corporate Debt has grown at a CAGR of c. 16% since 1993 to today,

reaching 50% of Emerging Markets debt universe in 2012

• Total Emerging Markets debt outstanding increased 16% in 2013 to

reach a new high of US$16 trillion

• Growth in 2010-2013 was due mainly to increased issuance by

Investment Grade rate corporates maintaining the relative high credit quality of the EM corporate debt universe

Source: Size and Structure of Global Emerging Markets Debt (July 2013) , Merrill Lynch, BIS, JP Morgan, Bond Radar, Dealogic, Deutsche Bank., JP Morgan, Bloomberg. (1) Based on Ashmore estimates.

Emerging Market Debt Universe Historic Emerging Markets Corporate Debt issuance

EM Corporate Credit – A Sizeable Universe Already

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71 93 121 153 58 137 203 183 302 324 350

50 100 150 200 250 300 350 400 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 (F) US$bn

1.0 1.2 1.4 1.7 1.7 2.1 2.2 2.5 2.6 3.3 3.9 4.7 5.4 6.4 8.0 8.2 10.1 11.9 12.7 14.0 16.1

5 10 15 20

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 (est.)

US$ trillion

Total Corporat e Debt Total S

• vereign Debt

0% 20% 40% 60% 80% 100% 2010 2011 2012 2013 (est.) Non-IG IG

Issuance by Rating

• 1. Driver of global growth
• Emerging Markets (EM) expected to grow at 5.5% in 2014 compared to

Developed Markets (DM) growth rate expected to average only 2.2%

• EM is generating around 50% of global GDP (PPP basis)
• 2. Favourable demographics
• Over 75% of world’s landmass and 85% of global population
• Growing middle class with high proportion of savings (household savings rates of
• ver 30% in most EM countries vs. less than 10% in most developed countries)
• 3. Reduced dependency on developed world
• Over 90% of oil and gas reserves and 70% of coal reserves
• Approx. 67% of the world’s total foreign exchange reserves
• EM countries now export more to China than to the United States
• EM countries have not only fared much better in the credit crisis but have an

increasing global economic presence

• 4. Developing capital markets
• EM Fixed Income market US$11.7 trillion expanding by over 7% in 2011
• EM sovereign debt issuance of US$75bn and corporate issuance of US$280bn in

2010

• EM stocks represented 32% of the market cap of stocks worldwide at end of 2010

but only 13% of the MSCI

• EM IPO volume made up 69% of global volume in 2010

Sources: IMF, Bloomberg, Ashmore, BIS, UBS, JP Morgan.

Emerging Market fundamentals continue to demonstrate the attractions of the asset class

Emerging Markets Environment

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0% 1% 2% 3% 4% 5% 6% 7% 8% 2005-2010 2011E-2015E

Real GDP Growth

Emerging Markets Developed Markets

31% 37% 48% 54% 69% 63% 52% 46% 0% 20% 40% 60% 80% 100% 1990 2000 2010 2016E

GDP based on PPP % of world total

Emerging Markets Developed Markets

Superior Economic Growth Outlook Increasing Global Economic Presence

Emerging Markets proved convincingly in 2012 and 2013 that they do not rely on growth in Developed Markets to fuel their own growth. NOW that growth in DM is picking up EM is well positioned to benefit with cheaper local currencies and already adjusted interest rates

Current State of Play

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Drivers of growth in Emerging Markets

• Growth in EM is now fuelled by local consumption, which is supported by demographics and wealth accumulation over the last

decade

• EM countries are trading with each other, financing each other more directly and through local banks
• Leverage is lower in EM for both sovereign and corporate balance sheets, which gives more flexibility to EM central banks
• DM monetary policy backdrop remains supportive, while EM interest rates have already adjusted to a large extent
• Risk taking is better compensated in EM credit which trades at historical wide levels compared to DM credit

Strong fundamentals of Emerging Market Corporate Debt

• Relatively strong economic growth in Emerging Markets vs. Developed Markets
• Less export dependency on Developed Markets
• Lower debt to GDP at consumer, corporate and government levels
• Reduced fiscal deficits and higher levels of reserves
• Improving economic and political fundamentals and stability
• Banking systems are much better capitalized
• Increasingly better corporate governance and transparency

Private Debt in Emerging Markets

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What is Private Debt?

• Wide range of deals, including:

― debt financing ― loans ― private placements ― club/mezzanine deals ― less-liquid securities ― trade receivables Advantages of Private Debt

• Higher expected returns
• Stronger covenants and senior creditor status
• Lower volatility
• Stronger relationships with issuers, better information flow
• Stronger negotiating position compared to investing in public bonds

Disintermediation of the banks

• International and local banks deleveraging, especially European Banks
• Asset Managers can originate better deals; not constrained by bank’s syndicate desk budgets
• Direct access to management, information is not “interpreted” by bankers
• Cutting out structuring fees (2.0% - 2.5%) benefits the investor
• No competition for a percentage of the allocation

Current opportunity of dedicated strategy

• Strong current need for term-funding drive premium to new all time highs
• Relative fundamentals compared to Developed Markets are highly attractive

― continued growth in Emerging Markets corporate debt theme ― strong balance sheets of issuers ― superior credit metrics

• Opportunity for lock-up product to match liquidity profile of assets

Why banks are not coming back soon

• Western Europe has been the biggest international lender to EM and has been the worst hit by the financial crisis
• Capital constraints reduce ability of Western European banks to sell assets in EM, clogging up balance sheets
• Basel 3 adoption and new rules for risk waited assets (RWA) calculation constrains ability of banks to underwrite loans
• Banks focus on safest possible loans, with little appetite for the High Yield market

Source: BIS

Private Debt Economics

Private Debt issuer profile Emerging Markets Corporate Debt universe Supply of Loans (Private Debt) Typical profile:

• Medium-sized company
• Good cash flows
• Low leverage
• Bank financing from local banks
• Un-rated (parent company may be rated)
• Un-listed or small local listing
• Companies across 43 countries (as per JP Morgan

CEMBI BD Index)

• Number of representative countries in the Index has

grown by a factor of 3 over the past ten years

• More than 600 issuers
• Total universe size (including hard and local currency)
• ver $7 trillion
• Historically, banks were main providers of debt, but this

stopped post-2008

• Increased capital requirements (Basel III) for banks

means only the largest and best-rated corporates have reasonable access to capital

• More than $300bn of bank credit provided to the

Emerging Markets has been withdrawn by EU banks alone since 2008

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Private Debt Opportunity & Characteristics

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The opportunity

• Significant value and transactional scope available to providers of term capital in the private debt markets
• Reduced competition from traditional players whom are strongly focused on liquidity
• EM corporates are outgrowing their own local banking systems

Strong negotiating position can translate into higher returns

• As growth is picking up, demand for Private Debt capital at the moment far exceeds the available supply
• Higher demand and lower supply drives yields higher for Private Debt
• Traditional asset managers in Emerging Market corporate debt showing strong preference for exposure to more liquid markets

Stronger bargaining power compared to traditional public market debt

• Direct negotiations with management contribute to better understanding of the credits
• Private Deals have tighter covenants compared to public markets as changes/waivers are easy to grant later
• Ability to influence terms of transactions
• Ability to negotiate security package , draft own documentation
• Ability to negotiate a Loan to Value (‘LTV’) of Collateral ratio and set up margining mechanism

Reduced volatility

• Private Debt suffers very little volatility, as there are no banks involved and the investors tend to be dedicated EM players
• Lack of liquidity in the secondary market strong deterrent for investors to take hasty decision to exit transactions
• Typical transactions are amortizing, short-duration (2-3 years average life) deals which contributes to lower volatility
• Most loans are floating rate hence little exposure to moves in US Treasuries

There are attractive opportunities to lend in all five major geographies of Emerging Markets

Geographical Opportunities – Private Debt

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Asia CIS/CEE Latin America Africa/ME Key drivers

• Banks focused on

benchmark-sized deals

• Strong preference for

liquidity from investors

• Diverse corporate universe

with large number of existing relations

• Ashmore presence on the

ground generates good deal leads

• CEE- Foreign bank

deleveraging leaves locals starved for cash

• Russia – Dominant state
• wned banks focused on

large quasi sovereign corporates

• CIS – Undercapitalised

locally owned banks cannot support the expansion capital needs of the larger corporates

• Small & medium sized

corporates find it difficult to get prompt access to the capital markets

• Banks prefer shorter

maturities while issuers are looking for longer

• Good opportunities exist to

leverage Ashmore’s existing lending relations in the region

• Africa – Nascent local capital

markets cannot support the need for capital of the larger corporates with expensive capex plans

• Middle East – Western

banks that used to be very active in the region are under pressure to reduce balance sheet Countries

• China
• India
• Indonesia
• Philippines
• Russia
• Ukraine
• Georgia
• Azerbaijan
• Romania
• Croatia
• Mexico
• Brazil
• Colombia
• Chile
• South Africa
• Nigeria
• Egypt
• Israel
• Turkey
• UAE

While there is no specific industry bias, we are seeing attractive opportunities for direct lending in the following areas:

Industry Themes – Private Debt I

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Utilities Infrastructure Mining / Resources

Key drivers

• Global demand
• Rising energy prices
• Industrialisation
• Global climate change
• Geopolitical uncertainties
• Economic growth and development

— World Bank estimates that developing countries

need to double spending from 2-4% of GDP to about 5.5% of GDP per year

• Availability of funding

— Current account surpluses — Infrastructure funds

• Urbanisation
• EM demand growth
• OECD demand growth
• Rate of development of new supply
• Ease of distribution
• Availability of refining
• Concentration capacity
• Ease of access to labour, power and water

Segments

• Electricity generation
• Electricity distribution
• Natural gas generation
• Natural gas distribution
• Hydroelectric
• Water utilities
• Telecommunications
• Transportation, including ports
• Waste management and water treatment
• Building materials
• Precious metals
• Base metals
• Coal

Industry Themes – Private Debt II

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Energy Food and Agriculture Healthcare Key drivers

• Global demand
• Rising energy prices
• Industrialisation
• Global climate change
• Geopolitical uncertainties
• Rising incomes in EM fuelling global protein

demand

• Supply limited by diminishing yields and

availability of arable land

• Commodities as an asset class increasingly

attracting “inflation hedge” investors

• Brand and distribution key in processed food

segment

• Consumer spending power
• Expansion of health insurance schemes
• Complexity of healthcare distribution
• Genericisation of pharmaceuticals
• EM demographics
• EM GDP growth and political reform

Segments

• Gas / Oil
• Hydro
• Renewables / Clean
• Machinery
• Agrochemicals / fertilizers
• Agricultural production
• Processing / distribution
• Land
• Manufacturing
• IT Healthcare solutions
• Hospitals
• Care Homes
• Pharmacies
• Primary care for profit
• Insurers / HMOs

While there is no specific industry bias, we are seeing attractive opportunities for direct lending in the following areas: