Despite the increasing volatility in emerging markets, Fitch Ratings said that going forward, CDOs in the sector continue to offer notable benefits to investors, especially in the face of U.S. hardships.
Fitch's Global CDO Quarterly, issued last week, said that, emerging market CDOs have performed well overall through the Asian, Russian and Argentine crises. However, the volatility in emerging markets is far from over, with Brazil currently at the top of the list for shaky markets.
"While we survived an Argentine default, an Asian crisis and a Russian crisis, there continues to be volatility, and Brazil is a particular case where there is quite a bit of exposure and the credit quality has been deteriorating," said Greg Kabance, an analyst at Fitch. However, Kabance also noted that despite this volatility, investors should maintain interest in CDOs in those markets. "You can construct a pretty good portfolio using emerging market [CDOs] as a subset to increase diversification, and to protect yourself from a downturn in the U.S. Recovery rates have been as high, if not higher than some U.S. markets," Kabance said.
Since 1995, Fitch has rated 29 tranches from 15 CDOs concentrated with emerging market assets, the report said. Of those transactions, Fitch has downgraded only four tranches and upgraded five. And interestingly, each of the rating actions came primarily as a result of weak performance in U.S. high-yield collateral.
In the spring of 2001, Fitch issued a study that said Latin American default statistics were consistent with similarly rated segments of the U.S. bond market. "While currently default rates are climbing in both sectors, the data underscores Fitch's belief that properly structured emerging market CDOs can perform on equal footing with their domestic counterparts," the report said. Although the report only focused on Latin America, the rating agency said that it expected other emerging markets to reach similar conclusions.
In the past few years, the market has seen fewer emerging market CDOs. Some market analysts speculate that the cause of the decrease is a result of past experiences where investors were badly burned by emerging market CDOs. "I guess that emerging market CDOs generally carry a bad name, but really the performance has been as good, if not better than the domestic counterpart," Kabance said. "I think that there's a lot of headline risk, and investors have been less eager to get involved in these deals. We think from a credit side, that's not necessarily true."
Kabance also noted that some countries within emerging markets are able to separate from downturns within the region, as has been the case with Mexico throughout the Argentine crisis, and with northern Asia as it survived and separated itself from the Southeast Asian countries during the Asian crisis.