This month, our fixed income teams discuss the drivers behind emerging and developed market convergence, what the US hybrid boom has in store, the continued popularity of money-market funds, and the ups and downs of high yield.
Read this article to understand:
- What is driving emerging and developed markets closer
- If and when money might start flowing out of money-market funds
- The key high yield themes that emerged from earnings season
Welcome to the April edition of Bond Voyage. With spring putting wind in our sails, this month we focus on market drivers, stopping for a check-up on fundamentals in high yield.
Emerging market debt: Around the world
Fiscal shenanigans in Brazil and Colombia along with rancorous politics in Romania, and most recently Turkey, do grab headlines, and at times can re-affirm people’s biases against EM. On the desk, we are quick to point out confirmation bias among team members, which is a natural tendency to interpret information in a way that confirms or supports one's prior beliefs.
Of the 70 countries in our universe, we have a positive fundamental view on 32. These are not confined to a single region, nor are they all commodity producers, or restricted to investment grade. We expect several rising stars in the BB-rating category to reach investment grade, like Oman, Morocco, Guatemala and Azerbaijan. Low debt and a commitment to reform and credible economic policy are key characteristics of these countries. Meanwhile, Egypt, Pakistan and Sri Lanka continue reform and fiscal consolidation efforts with the support of the IMF. Argentina and Senegal are expected to sign new programmes in the coming months.
The credit quality of the EM universe has improved steadily since the early 2000s.
The credit quality of the EM universe has improved steadily since the early 2000s. In the past, DMs were bigger and more effective than EMs and had more firepower. Some EMs now have more economic firepower and are more effective than their DM peers. We would expect convergence from here to be driven by improving structural factors across EM, as DM economies face ongoing challenges.
We have been running our internal rating model, which assigns a quantitative rating, for a number of years and have been tracking the evolution of EM credit quality since 2010. More recently, we thought it would be interesting to see how EMs stack up to DMs (see Figure 1). Yes, DM country ratings are higher – this won’t come as a surprise. But what was interesting was how much of the credit rating was driven by structural factors like individual wealth, economic size and governance. While these factors are undoubtedly important and act as a bulwark against shocks, they are unlikely to impact markets. In contrast, the cyclical components of the rating, like growth, inflation, public and external finances, are more likely to be market moving. Interestingly, many DMs – like the UK and France – are as cyclically vulnerable as some of EMs’ more challenged credits, like Colombia and Romania. In contrast, many EMs like Saudi Arabia, Indonesia and Poland are in a cyclically more resilient position.
With metrics that are relatively strong against similarly rated DM peers, high-quality sovereign credits like Chile and Poland appeal to buy-and-maintain investors. Qatar and Kuwait have recently been reclassified as developed markets and will no longer be eligible for the J.P. Morgan Emerging Market sovereign bond indices.
In the corporate universe, a growing number of issuers are present in both EM and DM indices, such as America Movil, Altice, Teva, Macau Gaming. This has meant a growing area of crossover from a research perspective, as these names are relevant to both DM and EM investors, with the same names being held in different strategies.
We are also increasingly able to benefit from individual ideas where boundaries are blurred. For example, BBVA Mexico, a key and strongly performing subsidiary of the wider BBVA Group, offers a significant premium for bonds it issues directly. We feel this premium is unjustified given the subsidiary’s underlying fundamental position.
Figure 1: Breakdown of EM and DM strength
Source: Aviva Investors, as of March 27, 2025.
Investment-grade credit: Why did the hybrid cross the pond?
Corporate hybrids are a type of financial instrument that combines elements of both debt and equity. They typically offer higher yields than traditional bonds but can come with more risk. Hybrids are often used by companies to raise capital without diluting their equity.
The European corporate hybrid market has become more standardised due to several key factors:
1. Issuer flexibility: Companies have adapted their hybrid structures to respond to changing market conditions, ensuring stability and predictability.
2. Established frameworks: Long-established criteria and methodologies from rating agencies like Moody's and S&P have provided a consistent approach to evaluating hybrids.
3. Market demand: There has been strong demand for hybrids from investors seeking higher yields and diversification benefits, which has encouraged issuers to adopt more standardised structures.
4. Successful track record: Over the past decade, hybrids have proven their reliability through various market scenarios, reinforcing their role in corporate capital structures.
Hybrids have proven reliable and are now a permanent part of many companies' financial structures.
Hybrids have proven reliable over the past decade and are now a permanent part of many companies' financial structures. They are especially useful for companies with long-term investment needs, like utilities, and private firms that can't easily access traditional equity.
Recently, Moody's updated its methodology, leading to significant growth in the US corporate hybrid market. This growth is expected to continue, potentially surpassing the European market within the next 12 to 18 months. However, the US market is less standardised, with varying issuer commitments and structural differences.
As hybrids become more common in investment-grade markets, funds will need to include them to avoid missing out on potential returns. This shift will add more risk to the investment-grade universe, complementing high-yield and deeply subordinated financial instruments.
In summary, hybrids have crossed the Atlantic to tap into new markets, bringing their unique benefits and challenges.
Liquidity: The seven-trillion-dollar question
In March 2025, US money market fund (MMF) assets reached a record $7 trillion. Including assets outside the US, the global total is over $10 trillion, making up about 15 per cent of all global fund assets. This huge amount of money in MMFs shows how much investors value these low-risk investments.
Key points and implications for investors
1. Need for liquidity: Investors need liquidity, especially in uncertain times. MMFs are low-risk and can be easily accessed, making them a safe place to keep money.
2. Attractive yields: Despite high interest rates, MMFs offer yields that beat inflation, making them appealing. This mix of safety and good returns keeps investors interested.
3. Historical patterns: After the 2008 financial crisis, MMF assets fell slowly over two years as rates were cut. In less severe rate-cutting periods, MMF assets either fell slightly or stayed the same (see figure 2).
4. Potential changes: While MMFs are popular now, investors might shift to short-duration bonds for higher yields with slightly more risk. Combining MMFs with these bonds could offer better overall returns.
Looking ahead
The big question is: when will money move from MMFs back to riskier investments? With high rates and ongoing uncertainty, MMFs are likely to stay popular for now. But as rates eventually drop, we might see a gradual move to higher-yield investments like short-duration bonds.
Overall, this trend shows that investors are being cautious, prioritising safety and liquidity while still seeking good returns. This balance is important in today's complex financial world.
Figure 2: US MMF total financial assets (US$ millions)
Source: Federal Reserve, Aviva Investors, as of March 27, 2025.
High yield fundamental check up
2025 has been full of uncertainty, with trade wars and conflicts in Ukraine and the Middle East dominating the headlines. We have taken a step back to review how European and US high yield corporate fundamentals have fared in the latest earnings updates. With the reporting season ending, here are the key themes we see.
European high yield
In the fourth quarter of 2024, European high yield’s upgrade-to-downgrade ratio stayed below one, meaning there were more downgrades than upgrades (0.85 upgrades for every downgrade). That’s an improvement from 0.8 in Q3. At the index level, rating quality declined slightly, due to better-quality (BB+) rising stars leaving the index for investment grade.
High yield fundamentals were very resilient until the third-quarter earnings but slid in Q4, lagging investment grade, especially on leverage. Corporate leverage, the ratio of debt to assets, increased slightly in Q4 due to weaker profitability (from 3.45 to 3.51, meaning companies were more indebted). Similarly, interest coverage, which is better when higher, slipped to near its trough, dropping to 4.62, from 5.24 in Q3.
European high yield fundamentals were very resilient until the third-quarter earnings but slid in Q4.
US high yield
In the US, the story is more positive, with upgrades continuing to outstrip downgrades by about 1.1 times. Balance sheets for US high-yield issuers remain strong, with fourth-quarter 2024 credit metrics showing modest improvements across the board. The most notable developments include a decline in leverage after three quarterly increases, and an uptick in interest coverage following eight consecutive quarterly declines.
EM high yield
Meanwhile, the fundamental backdrop for EM corporate issuers continues to be stable. Leverage ratios have ticked up marginally to around 2.4, which is still significantly lower than for DM high yield. Interest coverage has declined slightly to around 4.7 – roughly mid-way between US and European issuers’ ratios.
