Pemex and Fallen Angels in Emerging Markets
04 April 2019
Earlier this year, Fitch Ratings downgraded Pemex, the Mexican state-owned oil company, to one notch above non-investment grade. Although the company still has a mid-BBB blended rating and remains in investment grade indices, a further downgrade would have a meaningful impact to emerging markets high yield bond investors given its $100 billion in total debt ($66 billion of which is included in U.S. bond benchmarks). However, a downgrade to junk status is not written in stone. Although long plagued by inefficiency and underinvestment, the company is currently trying to execute a turnaround plan that focuses on reducing its massive debt load. In addition, Mexican President Andres Manuel Lopez Obrador’s administration has proposed tax breaks for the company valued at MXN 90 billion over the next several years. Nevertheless, the bond market appears to expect further pain, judging by the loss in value of Pemex bonds over the past year.
Pemex Downgraded But Still Investment Grade: Pemex 6.5 March 2027 Bond Price
Source: Bloomberg. Past performance is no guarantee of future results. For illustrative purposes only.
What could a downgrade to junk mean? A look at the behavior of previous emerging markets “fallen angels,” or bonds of issuers originally rated investment grade and subsequently downgraded to high yield, may provide some insight. The largest emerging markets fallen angels in recent history followed the sovereign downgrades of Brazil in late 2015 and early 2016 and Russia in early 2015.
As a result of the sovereign downgrades, several state-owned and quasi-sovereign entities were also downgraded. In the cases shown below, prices fell and yields rose significantly ahead of the downgrade as investment grade investors sold their holdings, and subsequently recovered. Fallen angel investors therefore acquired these bonds at attractive yields, and further benefitted as prices recovered following the downgrade.
Prices Recovered Following Rating Downgrades
Brazil: BNDES 4 April 2019 Bond Price
Russia: VEB Finance 6.902 July 2020 Bond Price
Source: Bloomberg. Past performance is no guarantee of future results. For illustrative purposes only.
With a market cap of approximately $420 billion, high yield bonds make up a substantial part of the overall emerging markets corporate bond market, but a downgrade of Pemex would clearly have a big impact. In addition there are approximately $70 billion of bonds rated at one-notch above junk status and on watch for further downgrade (this figure does not include Pemex, which is not currently on watch for downgrade).1 The good news for investors is that historically, high volumes of fallen angels has provided strong returns due to the forced selling that occurs prior to the downgrade. Further, fallen angels tend to be higher quality than the broader high yield universe, providing a cushion in volatile market environments and against default losses.
IMPORTANT DEFINITIONS AND DISCLOSURES
1Source: ICE Data Indices as of 2/28/2019, based on par amount
Important Disclosure
This is a marketing communication. Please refer to the prospectus of the UCITS and to the KID before making any final investment decisions.
This information originates from VanEck Switzerland AG which has been appointed as distributor of VanEck products in Switzerland by the Management Company VanEck Asset Management B.V., incorporated under Dutch law and registered with the Dutch Authority for the Financial Markets (AFM). VanEck Switzerland AG’s registered address is at Genferstrasse 21, 8002 Zürich, Switzerland.
The information is intended only to provide general and preliminary information to investors and shall not be construed as investment, legal or tax advice. VanEck Switzerland AG and its associated and affiliated companies (together “VanEck”) assume no liability with regards to any investment, divestment or retention decision taken by the investor on the basis of this information. The views and opinions expressed are those of the author(s) but not necessarily those of VanEck. Opinions are current as of the publication date and are subject to change with market conditions. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results. Information provided by third party sources is believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. Brokerage or transaction fees may apply. A copy of the latest prospectus, the Articles, the Key Information Document, the annual report and semi-annual report can be found on our website www.vaneck.com or can be obtained free of charge from the representative in Switzerland: First Independent Fund Services Ltd, Feldeggstrasse 12, 8008 Zurich, Switzerland. Swiss paying agent: Helvetische Bank AG, Seefeldstrasse 215, CH-8008 Zürich.
All performance information is based on historical data and does not predict future returns. Investing is subject to risk, including the possible loss of principal.
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.
© VanEck Switzerland AG
