Following a challenging period for emerging markets, question marks are now being cast over ‘quasi’ sovereign debt.
Investors withdrew more than $1 trillion (£694 billion) of capital from emerging markets over the past 12 months, and some commentators warn that quasi-sovereign debt is by no means safe from the diminishing capital flows and rising borrowing costs facing the developing world.
In the event of a broader economic downturn, quasi-sovereign debt (credit issued by corporates that are essentially government-backed or government-owned) is generally considered a safer option.
However, with emerging market governments now feeling the heat due to concerns over Chinese growth, the oil price fall and a strong dollar, some investors suspect state-backed enterprises could experience a similar investor exodus.
Claudia Calich and Charles de Quinsonas, manager and deputy manager respectively on the M&G Emerging Market Debt fund, point out that this part of the market could come under pressure due to weakening support from emerging market governments.
‘Emerging market credit quality peaked a couple of years ago, so the ability of the sovereigns to support the entities is weakening as the sovereigns get weaker themselves. There won’t be a crunch across the board, but investors will be pickier,’ said Calich.
‘In good times investors really underestimated the credit risk of those quasi-sovereign issues, and in downturns you realise that the credit portion of those issues is important,’ de Quinsonas added.
Nevertheless, the duo suggest that while macro risk is important, each issuer must be assessed on an individual basis.
‘I think we will see more research on the intrinsic corporate risk rather than the macro risk,’ de Quinsonas said.
Jan Dehn, head of research at Ashmore Investment Management, is not particularly concerned about any of the major quasi-sovereigns in emerging markets right now.
‘Most of them, if not all, have very strong backstops from their governments,’ Dehn added.
The research head suggests that quasi-sovereign debt should be analysed in the same way that other credit opportunities are, first accounting for the underlying risks associated with the corporate.
While lower commodity prices can be viewed as a headwind for state-backed oil and gas behemoths such as Petrobas and Gazprom, Dehn suggests the associated risks are offset by the stability that comes with state backing.
‘We like emerging market oil companies,’ he said. ‘It is unlikely that we will see widespread defaults. Like the US oil companies, these credits have cheapened a lot, but the difference between the US shale industry and the quasi-sovereigns in the emerging market energy sector is that the latter will not default.’
Although Brazilian oil major Petrobas is grappling with a lower oil price and a challenging economic backdrop, Dehn suggests the chances of a default are minimal because it is viewed as a core strategic asset by the government.
Calich similarly views Gazprom as a viable investment, despite the EU-imposed trade sanctions, because of its Kremlin-backing and fiscal strength as a stand-alone entity.
Kames emerging market debt specialist Scott Fleming has sought to take advantage of dislocations in the spread levels between some ‘quasis’ and their underlying sovereigns.
‘Pemex, which still provides around 30% of Mexican fiscal revenues and pays away the bulk of its earnings to the state, has seen a significant dislocation in spread levels from the sovereign and represents an attractive relative opportunity, particularly now that the sovereign looks set to wear some of Pemex’s unfunded pension liabilities,’ he said.
However, not all quasi-sovereign debt is easy to analyse. Calich warns that some of the Chinese state-owned enterprises are opaque, which is why investors should approach each situation on a case-by-case basis.
Meanwhile, Dehn highlights Venezuelan quasi-sovereigns as an area to avoid.
‘Against expectations, Venezuela was one of the best-performing sovereigns in the world last year and all bonds were paid in full. But unless Venezuela changes its economic policy they are likely to run out of reserves, which makes both its sovereign and quasi-sovereign bonds quite risky.’