The strategy of New York–headquartered fixed-income investment management firm Stone Harbor Investment Partners clicks well with the high yields and potential for price appreciation in bonds issued by cement producer Cemex. The Monterrey, Mexico–based company’s market position and its moves to shore up its balance sheets are even more of a draw. Although it’s engaged in a process of deleveraging, Cemex still controls a large share of the Mexican cement market, as well as having a sizable international footprint. Investing in companies like Cemex has helped Stone Harbor outperform its peers in emerging-markets corporate bond funds, a sector that has attracted increasing interest from institutional investors.
“Cemex was formerly an investment-grade company, but it lost its way a bit in a series of levered acquisitions,” says William Perry, portfolio manager for emerging-markets corporate debt at Stone Harbor. Cemex got into trouble after borrowing lots of short-term money from banks to make acquisitions and then finding itself unable to roll over those loans during the 2008–’09 financial crisis. “They did all the right things: sold off assets, raised equity and extended their maturity profile. Ultimately, they are working their way through a very deep trough in the cement market,” says Perry.
The recovering housing market in the U.S. offers the promise of higher growth in earnings, improving the ability of the company to deleverage and improve its credit profile. “Cemex is definitely geared to a rebound in U.S. housing,” says Perry. Stone Harbor expects earnings to rise because of cement sales to states where Cemex has operations, which include California, Nevada, Arizona, Texas and Florida. Also standing to bolster Cemex’s earnings is Mexico’s Transport and Communications Infrastructure Investment Program 2013–’18. Announced on July 15, 2013, by President Enrique Peña Nieto, the plan includes 60 new roads, seven ports, three passenger railroads, seven airports and enhancements to the nation’s telecom networks, including two new satellites. Investment into the project, expected largely to come from public-private partnerships, is estimated to be worth more than $100 billion.
Management efforts to implement a financial restructuring at Cemex paid off September 26 when Standard & Poor’s raised the rating for the corporation’s long-term credit, from B with a positive outlook to B+ with a stable outlook. “We expect the company to continue improving its cost structure and achieve increased efficiencies, which could result in ebitda margins above 17 percent during 2013 and 2014,” wrote Luis Manuel Martínez, primary credit analyst on Cemex for S&P in Mexico City, in a September 26, 2013, research note.
The same day, Cemex issued $1.4 billion in senior secured notes at 7.25 percent, maturing in 2021. More recently, on March 25, the company issued €300 million ($416.5 million) in senior secured notes at 5.25 percent, due 2021. Its majority-owned subsidiary, Cemex Finance, issued $1 billion in ten-year benchmark bonds at 6 percent due in 2024. The proceeds are being applied to pay off high-interest debt and to finance operations.
Stone Harbor has $52 billion of its $62.5 billion in assets under management in emerging-markets bonds on behalf of institutional investors, mostly in sovereigns. During the first quarter of this year, Stone Harbor’s $3.3 billion investment in its emerging-markets corporate debt strategy saw a 3.39 percent return, according to eVestment, a Marietta, Georgia–based investment data firm. This performance beats the 2.79 percent return of its benchmark, the J.P. Morgan corporate emerging-market bond index (broad diversified). Since its inception in 2007, the Stone Harbor emerging-markets corporate bond strategy has returned 72.55 percent, according to eVestment. This cumulative figure also handily beats the benchmark, which returned 60.34 percent over the same period.
Overall, institutional investors have significantly expanded holdings in emerging-markets corporates after a slow start in 2007. At year-end 2013 institutional investors held $36.7 billion in emerging-markets bonds, according to eVestment. By comparison, in 2011 institutional investors held only $380 million in emerging-markets debt.
In 2013, although institutional investors began to withdraw funds from emerging-markets corporate funds in June, by year’s end the net outflow came out to $1.28 billion. According to eVestment, institutional investors have increased their searches on emerging-markets bonds within the company’s Advantage database, indicating a high level of interest that could lead to higher allocations to these markets in the future.
The growing volume of new hard-currency bond issues by corporations is part of the ongoing evolution of investment product offerings in emerging markets, according to Samy Muaddi, analyst and portfolio manager at T. Rowe Price in Baltimore. “Sovereign credit has gone from roughly a double-B asset at the onset of the industry in the 1990s towards a triple-B asset class,” he says. Muaddi continues on to explain that emerging markets — minus key exceptions like Ukraine, Venezuela and Argentina — are now a triple-B asset class, with Brazil and Mexico, for example, trading at a small spread over U.S. Treasuries. “It’s a natural maturation for the [emerging markets] corporates to go abroad and borrow as well,” says Muaddi.
When corporates go abroad they are typically lengthening their liability profile, which, according to Muaddi, “is very credit positive.” Onshore, corporates typically offer lenders and investors only short-term debt, which has to roll over frequently, whereas offshore they can typically issue seven-year notes, he says. “So [going offshore] is positive both from the investor perspective and the issuer perspective.”
Stone Harbor’s Perry expects emerging-markets corporates, relative to emerging-markets sovereigns, to outperform in a bull market and underperform in a bear market, as in the latter they are generally smaller and less liquid. “There is a large retail presence in emerging-markets sovereigns through exchange-traded funds, and this makes them more volatile to individual investor sentiment. But since institutional investors by and large are the buyers of emerging-markets corporates, this sector is less volatile.”
The creditor constituency for emerging-markets corporates is broad, which helps its stability, according to Perry. It includes not just funds specializing in emerging markets, like Stone Harbor, but also U.S. insurance companies; U.S. and European pension funds that have in-house managers who invest in emerging markets; as well as private banks and wealth management firms. These investors support a vibrant market in new corporate issues, which has been $300 billion in recent years, with another $300 billion expected in 2014. The issues are offered in terms of five to 30 years, a range that makes emerging-markets corporates “start to look much more like developed-market corporates,” says Perry.
Perhaps the biggest surprise for those new to this investment class, however, is that emerging-markets corporate issues are now predominantly investment-grade. “Many folks view emerging-markets corporates as a frontier market. It’s not,” insists Perry. “It’s 70 percent investment-grade, with the high-yield portion at 30 percent.”
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