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Alternative Market Briefing

Other Voices – Inefficiencies in the Emerging Markets High Yield Debt Asset Class

Wednesday, February 29, 2012

From André Simon, Galloway Capital (www.gallowaycapital.com):

There is a common belief that Emerging Markets High Yield (EM HY) should pay a higher yield than their US HY peers (difference is currently around 200bps) because of EM’s lack of Rule of Law, which in turn affects EM’s recovery rate in case of a default. We at Galloway do not entirely agree with this common belief and instead argue that there is a huge market inefficiency in the EM HY asset class.

While we know that recovery value is an important issue (it would be thought that a better legal system with efficient Rule of Law would provide a higher recovery value), we see that in reality the unsubordinated debt from EMs trade at around 30% when an EM company stops coupon payments. This 30% handle is a number that we believe is not much different than in the US. Considering that we have a similar selling price in EM and the US once the company stops paying its coupons, the main difference in yield spreads between US HY and EM HY should have more to do with rate of default than with recovery value.

We recently reviewed some interesting data from JPM that compared EM HY versus US HY. In said study, from 2003 to 2010 the average yearly return has been over 300bps higher in EM (spreads usually vary between 200 to 300 bps), while EM enjoyed a 42% lower rate of default! We extracted from this JPM research the period starting in 2003 because until then the HY universe in EM was too concentrated in Soverei......................

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