With nearly half the world’s population in lockdown, global demand and supply chains have been severely impacted by the coronavirus pandemic.
Global economic deterioration has been slowed by extraordinary fiscal and monetary policies put in place by governments and central banks around the world.
For example, the US has implemented a $2trn stimulus package to help consumers and impacted industries navigate this crisis.
Similar measures have been implemented in other developed and emerging markets (EM) and we believe EM companies are relatively well positioned to weather this downturn.
EM corporate bond valuations have cheapened dramatically amid broader volatility in global risk markets. The CEMBI spread widened by about 400 basis points in late March and today sits at around 550 basis points.
The recent moves represent the second largest spread widening in 20 years, after the 2008 Global Financial Crisis.
We believe current valuations represent a "once in a decade" investment opportunity. Since its inception in December 2001, the CEMBI has historically returned around 14% in excess of US Treasuries after reaching such cheap valuations.
The CEMBI has historically generated positive excess returns above 10% in the subsequent year after the spread has exceeded 450 basis points.
To identify individual investment opportunities, we seek corporate bonds of issuers with the strongest liquidity positions among the credits that have experienced the most spread widening.
To determine how strong companies' short-term balance sheets must be to withstand this downturn, we make assumptions about how long current financial conditions are likely to prevail and focus on the following three metrics to indicate these credit strengths.
Liquidity in excess of short-term debt
We favour companies with cash and marketable securities (high quality government bonds and bills). The location of cash in a company's capital structure is critical since reported consolidated cash might not be fully available to service debtholders due to upstream dividend leakages, cash tied to specific projects or capital controls.
Solid current ratio
We favour companies with short-term assets well in excess of short-term liabilities. For example, we seek enough working capital to cover salaries, administrative expenses and maintenance expenditures if a company were to stop operating for a short period of time.
Cost curve leaders
Last, we favour top-quartile cost leaders with healthy operating and free cashflows. We believe these companies will likely outlast other companies in their sectors and will attract a disproportionate share of global capital.
In addition to identifying issuers that meet these key criteria, we favour two investment strategies that seek to take advantage of risk-return potential while avoiding potential defaults.