Dimitry Griko explains where investors should look to find strong growth. It starts with discriminate buying as the markets pick up again.
Anyone with even the most rudimentary knowledge of investing knows the best time to commit your money to the market is after it has bottomed out following a crash. While any sort of event with the potential to send indices tumbling by double digits in a single week - as was the case when the coronavirus crisis erupted earlier this year - often proves to be disastrous for certain sections of the market, the panic associated with this type of correction inevitably results in indiscriminate selling.
This tends to result in solid businesses whose fundamentals are unaffected by the original catalyst for the crash being dragged down along with everything else. Yet buying at the bottom of the market is easier said than done when every newspaper headline is warning of a financial meltdown, and trying to time your entry to coincide with the moment valuations reach their lowest point can be likened to catching a falling knife.
Although this asset class has rebounded to its starting level, the recovery has been lopsided."
Even waiting for a slight rebound in the market does not guarantee you have avoided the worst of the crash, as it is difficult to separate the green shoots of a market recovery from a dead-cat bounce.
Buying at close to the bottom of the market this year was made all the more difficult by the speed of the fiscal and monetary response from governments and central banks, as well as the dominance of tech stocks, which proved to be beneficiaries of the lockdown. As a result, many investors are now kicking themselves after missing out on "the buying opportunity of the decade", with most world markets bouncing back from their March lows to this year's starting levels - and in many cases, even higher - in a matter of months.
Fortunately, however, some areas of the market are still trading at depressed levels - although it may not be immediately obvious to the untrained eye. For example, the emerging market corporate debt asset class is sitting above its starting level for the year, suggesting that the opportune moment for bargain hunters to buy in has already been and gone.
It is true the easiest gains have already been made - after the coronavirus crisis first hit, many credits in this area of the market found themselves trading well below their recovery values. Investors soon realised these levels made no sense, and the market quickly rallied.
But although this asset class has rebounded to its starting level, the recovery has been lopsided, concentrated in higher-quality debt, while its lower-quality equivalent still trades at depressed valuations.
Just as there is indiscriminate selling on the way down, there is discriminate buying when the market is on the way back up, with many fund managers refusing to touch any debt rated in the lower-quality bracket while the outlook remains uncertain.
As a result, by focusing on the underlying business fundamentals of individual securities in emerging market high yield debt, it is possible to pick up credits with attractive double-digit yields and controlled risks.
Even with increased probabilities of default, with diligent issuer and security selection liquidity troubles will be managed through creditor friendly restructurings such as maturity extensions, increased coupon levels, pay-in-kind coupons and will maintain a decent level of upside. A number of issuers have already performed creditor-friendly restructurings that give them greater control of their short-term liquidity while the outlook remains uncertain.
Of course, the economic backdrop looks worse than it did at the start of the year, while the second wave of the virus spread increases the probability of prolonged economic turmoil, but these risks are better priced in emerging market high yield debt: yields of close to 10% in good quality names are still available, compared with low single digit yield on its equivalent in the US, where defaults are expected to be higher, GDP growth is lower and the economic bounce-back is likely to be less pronounced.
A second wave of the coronavirus has already hit most countries around the world and those that have so far escaped unscathed are likely to be hit at some point. However, emerging economies already showed greater resilience to Covid-19 than developed nations.
On average, their response to the pandemic's economic impact was more effective. Higher interest rates have enabled emerging markets central banks to cut rates with some of them launching quantitative easing programmes for the first time.
China launched massive infrastructure spending and in spite of its huge population was the most prepared and effective in the speedy containment of virus.
South-East Asian economies also took timely action. Middle East and African countries (except South Africa) experienced much lower death rates than the US, UK and France, supposedly due to much younger populations, and some of these economies will most likely post slight GDP growth this year.
Most countries are now much better prepared in terms of their healthcare systems and individuals are taking more precautions in their day-to-day lives. Most importantly three viable vaccines are showing good development progress with more to follow. All this taken together means that at last the long shadow of this pandemic is beginning to retreat especially across developing economies.
Patience is still required before all risks are removed from the table, but given we are fixed income investors, time is not a problem as we get paid to wait, in the form of double-digit yields.
As always though, the ability to make money in this asset class will depend upon taking a discerning approach to individual credit selection.
Dimitry Griko is chief investment officer for fixed income at EG Capital Advisors