Companies are playing an increasingly important role in emerging market hard currency debt investments. In this video, Luis Olguin, CFA, Portfolio Manager in William Blair’s Emerging Markets Debt (EMD) team, explains the benefits of company allocation to emerging debt portfolios; how investors manage corporate risk, which is different from sovereign risk; and our approach of allocating corporate securities to emerging markets hard currency debt portfolios.
Watch the video or read the recap below.
Companies are playing an increasingly important role in emerging market hard currency debt investments.
What are the benefits of a company allocation to emerging market debt portfolios?
There are several advantages to a business credit allocation in the current market environment.
First, corporate bonds generally have a lower duration than sovereign bonds, a key performance driver in times of higher and more volatile interest rates.
Second, over 80% of the corporate bonds we analyze are currently trading at a positive spread to their respective sovereign. For a manager able to appropriately manage these credit risks, this additional return can add to performance.
Third, corporate diversity also provides an assortment of investment drivers beyond the credit quality of a sovereign borrower. While sovereign risk is a driver of corporate bond returns, corporate credit drivers can often dominate, particularly when the sovereign credit landscape is stable or improving.
How do you manage corporate risks, which are different from sovereign risks?
We assess fundamental business risks through our Enterprise Risk Model and our Environmental, Social and Governance (ESG) Scorecard.
Our enterprise risk model takes a multi-angle approach to credit risk.
We examine an issuer’s financial risk using a financial model based on credit trajectory and potential downside.
The commercial risk of an issuer is annualized by studying the competitive environment of its sector and the market position of the issuer within it.
We assess a company’s management strategy by noting its policies, track record and plans for growth.
One of the most important risks in business analysis is debt structure risk. This examines the maturity profile of an issuer and the composition of its debt, which is crucial in assessing a probability of default.
Finally, we assess the degree of sovereign risk of the issuer by examining the macro, political and regulatory environment of the country, as well as the probability of a sovereign rating change given its effect on the ratings of corporate issuers.
Our ESG Dashboard is our tool for analyzing an issuer’s ESG risks. We built this dashboard based on SASB’s materiality factors, our assessment of what is material, and a dual materiality framework based on sustainability and business impacts. Our analysis is carried out through informational engagement with issuers and supplemented by third-party sources leading to an overall rating for the ESG pillars, an incident management assessment and an issuer outlook.
What is your approach to allocating companies to emerging market hard currency debt portfolios?
At William Blair, we use a systematic and repeatable framework for our business credit allocation.
Our process begins by taking the sovereign and corporate universes and applying ESG-related exclusions for violators of global standards and controversial sectors, as defined by William Blair’s internal policies.
We then match corporate and sovereign duration by country and applying our proprietary beta bucketing approach.
Using external ratings as a guide, we limit the maximum credit rating differential to limit excessive credit risk.
We then run a valuation filter, focusing on the historical spread relationship between the firm and the sovereign. This is important as we aim to enter a trade when it is historically more attractive.
Our fundamental analysis now plays a key role. Using our enterprise risk model and ESG analysis, our team of analysts provide their fundamental assessment of the issuer. This rating and the rating screen are then reviewed monthly by portfolio managers for potential investments.
This process is complemented by our ongoing monitoring as well as our formal bi-weekly performance assessment, which is carried out by the entire Emerging Markets Debt (EMD) team in an open discussion. .
Luis Olguin, CFA, is a Portfolio Manager of Emerging Markets Companies within William Blair’s Emerging Markets Debt (EMD) team.