In 2015 Emerging Market High Yield Debt (EMHB) manged to lock a total return of 3.2 per cent as per the BOFA Merrill Lynch High Yield Emerging market index, with the registered return being solely generated from carry return (7.5 per cent), which mitigated the negative return of 4.4 per cent from a price return basis.

Surely the main themes that hindered the index, on a price return basis, were primarily conditioned initially by the sanctions imposed on Russia in the first quarter of the year, but primarily the political turmoil in Brazil, which continued to weigh negatively on the index.

Other than that, iil prices, the Fed rate outlook and a weaker China were also determinants for a bumpy year within Emerging Debt market from the price return front. The weightings of Russia and Brazil on the EMHB index are significant at levels of 25 per cent and 23 per cent respectively.

Despite a notable decline in the last quarter of 2014, in which Russian high yield debt registered declines of circa 15 per cent, following the political strains with Ukraine, the said debt managed to snap back and re-position itself in the green by the first half of 2015 with solid gains close to 22 per cent, as political disturbance faded away.

As opposed to the milder situation in the second half of 2015 in Russia, Brazil was hit by corruption scandals primarily within Petrobras, an oil producer in which the Brazilian Government holds a 54 per cent shareholding, in addition to economic deterioration and political paralysis, which got increasingly interconnected.

This led to a downgrade below investment grade to BB+, by both Standard and Poor’s and Fitch, while Moody’s was the only rating agency which maintained its investment grade rating at Baa3, however with a review for a possible downgrade.

The country is now stalled in a long, and deep, recession with inflation just over 10 per cent. The BRL is down circa 30 per cent against the US dollar over the past year (compared to a 15 per cent fall for EM currencies in general), and President Dilma Rousseff is now facing possible impeachment proceedings.

All in all this pushed the 10 year hard currency sovereign yield to spiking levels of 7.3 per cent in the last part of December, now at 6.8 per cent levels. Clearly, a deteriorating situation which continues to push one of the largest emerging market economies into dire straits with spill-over effects on other emerging market countries.

On a positive tone, a trade adjustment should take place in response to currency devaluations, after the so-called economic J-curve effect takes place. This should help to keep the current account deficit under control and possibly reduce it over time for countries which have imbalances, amongst which Brazil.

The year ahead: outlook for EM debt

Oil prices, the Fed rate outlook and a weaker China, which were central views in 2015, will still be amongst the main themes in 2016, and any steepening in the US yield curve will possibly lead to wider repricing in emerging market bonds. Furthermore, along with a stronger dollar, EM currency weakness and rising borrowing costs, in addition to a slowing EM growth, will also hinder EM corporates and their ability to refinance and service their US dollar denominated debt.

That said, as spreads widen due to possibly specific country risk (eg. Brazil), in addition to market volatility, emerging market corporates which generate a chunk of their revenues from exports, should benefit from the depreciation in their currency through an increase in demand for their products and thus report stronger earnings. Surely a risky situation, but an opportunity for risk-lovers.  

Disclaimer: This article was issued by Jordan Portelli, Junior Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.