International Credit Portfolios

Investing in multiple markets and currencies offers opportunity and risks. But even investors who restrict holdings to one country should realize the bond issuers in that country may generate significant revenue and profit in other countries, exposing the investor to global risks.

International investing offers greater relative value opportunities. For instance, new issuance of corporate bonds in one country may exceed desired demand, lowering prices of corporates relative to corporates in other countries. Or subtle quality differences may exist. HY bonds in country Z may have a higher percentage of the most speculative bonds compared to HY bonds in country Y. If credit risk is expected to decline the more speculative HY of country Z are likely to outperform, all else the same.

The size of the emerging market (EM) bond sector has been increasing and is now similar in size to the U.S. high-yield (HY) sector. Although both are high yield and high risk, there are differences. In the EM sector:

  • Commodity and banking related businesses make up a much greater percentage of the bonds outstanding. That concentration is greater than it appears as much of EM banking is linked to those same commodity businesses.
  • Direct government ownership or stakes in companies is high. This gives an explicit or implicit expectation of support if there are credit problems. The risk is the local governments may favor domestic over international creditors if there are problems with the bonds. Even the legal rights of the EM’s foreign investors may be less clear.
  • The rating on EM non-government bonds may in some cases understate true quality as rating agencies typically will not rate an issuer higher that the sovereign credit rating of the issuer’s country.

In global bond portfolios:

  • Liquidity is a greater concern. The United States is the most liquid market with transparency of trade volume and price (i.e., public reporting). In other markets, there is less or no reporting.
  • Currency risk must be considered as a decline in value of the currency in which the bond is denominated reduces return to investors outside that country. This can be a bigger issue when interest rates of the bond are low, making changes in the value of the currency a bigger component of return for the foreign investor. Global managers may hedge the currency risk by selling forward or swapping the foreign currency for domestic currency of the investor.
  • Legal risk can be greater with less familiar or less developed legal protections and bankruptcy law.

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