Insuring the future of emerging markets

September 19, 2024

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Ongoing redistribution of wealth and changing demographics is leading to increasing investment opportunities in insurance companies.

Emerging markets (EM) have not only experienced faster growth than developed markets but have also seen an increase in incomes.¹ As a result, EM countries are contributing most to an increase in the global middle class.¹ It is estimated over 4 billion people, more than half the world’s population, can be considered middle class; this number grows 110-115 million per year, with the vast majority from Asia.²

As the middle classes accumulate wealth, there is a natural desire to protect and pass it onto future generations through insurance products and services. Investors can participate in this trend through adding exposure to the insurance sector. Given regulatory capital requirements, this is exclusively an investment grade (IG) rated sector and accounts for 2% of the market.³ This is less than half the weighting than in the comparable IG indices in the US (4.5%) and in Europe (4.1%).⁴

In EM credit, the insurance sector is almost exclusively Asian, more specifically North Asian, with Hong Kong the dominant issuing region followed by China.⁵ There has also been issuance from Korea and Thailand, and recently a debut issuer from Taiwan.

In the broader Asian credit context, we also believe Japan’s insurance sector offers opportunities. We expect more issuance as companies look to optimise capital structures through the continued issuance of subordinated debt.

A growing opportunity

There looks to be significant room for growth based on the current density and penetration of the insurance sector, especially in emerging Asia. India and China are at the development stage, where notable gains in insurance penetration is expected in the coming decade.⁶ Meanwhile, although Hong Kong looks highly penetrated, it benefits from its proximity to mainland China.

Regulators in less developed markets are only just starting to implement risk-based capital regimes (RBC) and to adopt International Financial Reporting Standard 17. Under this regime, insurers are required to take a uniform approach in calculating their capital requirements. There are three tiers of capital: unlimited Tier 1 (typically equity), limited Tier 1 (equivalent to bank AT1 issuance) and Tier 2. Tier 2 debt has been the most commonly issued amongst EM insurers. 

Figure 2: Capital tiers

Source: Muzinich & Co., as of August 31, 2024. For illustrative purposes only.

Similar to subordinated bank debt, there is uncertainty over whether insurance subordinated bonds will be called as this is subject to regulatory approval. Newer bonds come with a “lock-in” feature that links the call to the maintenance of a regulatory capital requirement that is generally far below the capital ratio at new issuance. EM insurers with access to hard-currency debt markets (US dollar-denominated) are also leaders in their respective markets, with trusted franchises and capital ratios considerably above regulatory minimum levels.

We believe the perceived complexity of the sector, combined with its modest weighting in EM indices, means it can be overlooked, and its risk appears to be mis-priced. This potentially provides a significant opportunity for investors with a thorough understanding of the sector and focus on deep, bottom-up fundamental analysis.

The month in credit

August was a strong month for credit, which continued to benefit from the rally in US rates. Within EM corporates, investment grade (IG) particularly benefited from the fall in US government bond yields and outperformed its US and European peers. Latin American IG also did well, boosted by long-dated commodity exposure.

High yield (HY) made gains on the back of seasonal low supply, inflows and positive sentiment as the US Federal Reserve Chair Jerome Powell announced: “The time has come for policy adjustment”.⁷ EM HY performed in-line with its US counterpart, demonstrating the rally in HY was a systematic ‘risk-on’ event. Like IG, Latin America was the best performer by region, while Asia underperformed as the property sector continued to drag on China’s growth prospects.

By sector, consumer goods performed, led by the Brazilian protein (beef) sector and IG Chinese online platform businesses. By rating, BBBs outperformed, buoyed by falling government yields and tighter spreads.

On the macroeconomic front, EM economies continued to appear robust after a solid set of second-quarter gross domestic product (GDP) releases. In India, despite a Q2 print of 6.7%, down from 7.8% in Q1, there was growth in the gross value added measure, highlighting greater alignment between these growth measures and increasing confidence in the underlying growth momentum.⁸

Indonesian GDP came in at 5.05%, slightly higher than consensus estimates of 5%, supported by strong export demand.⁹ Meanwhile, Thailand’s Q2 growth was better-than-expected at 2.3%, although this is expected to slow in the second half of the year after the change in prime minster (following the dismissal of the incumbent PM by the Thai Constitutional Court) raised doubts over the pace of US$14 billion of fiscal stimulus.¹⁰ Markets moved on quickly from this noise, as they did following the resignation of Japan’s PM Fumio Kishida, who resigned in a bid to boost the ruling Liberal Democratic Party’s popularity ahead of a general election next year.¹¹

Malaysia and Singapore met to discuss the creation of a special economic zone amid signs of ongoing growth in intra-regional trade ties and diversification of supply chains. Located in Johor, the Malaysian state bordering Singapore, companies in this zone will benefit from lower operating costs and land resources while having access to Singapore’s skilled labour and technology.¹²

Moving west, Turkey’s inflation expectations edged towards the central bank’s forecasts. The July survey showed market participants expect a slowdown in inflation in 12 months’ time to 30%, more than half July’s 61.8% inflation rate.¹³

In South Africa, the rand climbed to a 13-month high, buoyed by economic optimism and expectations of imminent Federal Reserve rate cuts. According to Finance Minister Enoch Godongwana, the coalition government formed after May’s elections, has bolstered investor confidence, fuelling a currency and stock market rally. ¹⁴

In Ukraine, over 97% of bondholders approved a US$20 billion debt restructuring.¹⁵ The deal, which involves a debt swap, will reduce the country’s debt to a level in-line with the International Monetary Fund’s programme objectives. 

Moving to Latin America, inflation estimates rose in Brazil - a worrying sign for the central bank still focused on lowering consumer prices back to target.¹⁶  While we continue to see the central bank maintaining the rate at 10.5% through year-end, any change depends on the currency. President Luiz Inacio Lula da Silva announced Gabriel Galípolo as his pick to lead the Brazilian central bank for the 2025-’28 term, removing a potential source of uncertainty.¹⁶

In Mexico, president-elect Claudia Sheinbaum named energy economist Victor Rodriguez Padilla as the next CEO of state-owned oil company Pemex in an effort to boost profitability and rescue the company from ballooning debt and recurring accidents, while she also seeks to jump-start Mexico’s green energy transition.¹⁷ The country’s central bank, meanwhile, cut its benchmark rate by 25bps to 10.75%.¹⁸ While the bank still sees inflation risks to the upside, it acknowledged weak economic activity in Q2. It also cut its growth forecast for 2024 and 2025, citing weak manufacturing in the US – the country’s top trade partner – as the contributing factor. Peru’s central bank was also in easing mode, implementing a 25bps cut to 5.50% on the back of easing inflation expectations.¹⁹

Past performance is not a reliable indicator of current or future results.

Risk: Reference to the names of each company mentioned in this communication is merely for explaining the investment strategy and should not be construed as investment advice or investment recommendation of those companies.

What to watch out for

• Brazil’s 2025 budget proposal: President Luiz Inácio Lula da Silva is set to release a budget plan for next year that is likely to displease financial markets and his leftist allies. The country’s fiscal policy remains the flashpoint between Lula’s administration and financial markets.
• Indian census: Originally scheduled for 2021, the exercise was delayed due to COVID-19 and many statistical surveys and estimates still rely on 2011 census data. It is expected to take 18 months to complete, with the results due to be released by March 2026, covering a period of 15 years.

Market Data - Credit

Past performance is not a reliable indicator of current or future results.

Source: ICE data platform. as of 31st August 2024. EMGB - ICE BofA Emerging Markets External Sovereign Index EMCB - ICE BofA Emerging Markets Corporate Plus Index,  EMIB - ICE BofA High Grade Emerging Markets Corporate Plus Index, EMHB - ICE BofA High Yield Emerging Markets Corporate Plus Index, Q690 - ICE BofA Custom Emerging Markets Short Duration Index, EMRA - ICE BofA Asia Emerging Markets Corporate Plus Index, EMIA - ICE BofA High Grade Asia Emerging Markets Corporate Plus Index, EMHA - ICE BofA High Yield Asia Emerging Markets Corporate Plus Index , EMRL - ICE BofA Latin America Emerging Markets Corporate Plus Index, EMIL - The ICE BofA High Grade Latin America Emerging Markets Corporate Index, EMHL - ICE BofA High Yield Latin America Emerging Markets Corporate Plus, EMRE - ICE BofA EMEA Emerging Markets Corporate Plus Index, EMIE - ICE BofA High Grade EMEA Emerging Markets Corporate Plus Index, EMHE - ICE BofA High Yield EMEA Emerging Markets Corporate Plus Index,. Index performance is for illustrative purposes only. You cannot invest directly in the index. Indices selected provide best proxy for highlighting performance of emerging market corporate bonds. For illustrative purposes only. 

Yield to Worst

Source: ICE data platform. as of 31st August 2024. EMGB - ICE BofA Emerging Markets External Sovereign Index EMCB - ICE BofA Emerging Markets Corporate Plus Index,  EMIB - ICE BofA High Grade Emerging Markets Corporate Plus Index, EMHB - ICE BofA High Yield Emerging Markets Corporate Plus Index, Q690 - ICE BofA Custom Emerging Markets Short Duration Index, EMRA - ICE BofA Asia Emerging Markets Corporate Plus Index, EMIA - ICE BofA High Grade Asia Emerging Markets Corporate Plus Index, EMHA - ICE BofA High Yield Asia Emerging Markets Corporate Plus Index , EMRL - ICE BofA Latin America Emerging Markets Corporate Plus Index, EMIL - The ICE BofA High Grade Latin America Emerging Markets Corporate Index, EMHL - ICE BofA High Yield Latin America Emerging Markets Corporate Plus, EMRE - ICE BofA EMEA Emerging Markets Corporate Plus Index, EMIE - ICE BofA High Grade EMEA Emerging Markets Corporate Plus Index, EMHE - ICE BofA High Yield EMEA Emerging Markets Corporate Plus Index,. Index performance is for illustrative purposes only. You cannot invest directly in the index. Indices selected provide best proxy for highlighting performance of emerging market corporate bonds. For illustrative purposes only. 

References

1. Brookings, ‘The Rise of the Global Middle Class’: An interview with Homi Kharas, as of January 22nd, 2024.
Middle class is defined as households with per capita incomes between US$10 and US$100 per person per day in 2011 PPP terms. Most recent data available
2. Brookings, ‘The Rise of the Global Middle Class’: An interview with Homi Kharas, as of January 22nd, 2024.
3. ICE Index Platform, as of 30th August 2024. ICE BofA High Grade Emerging Markets Corporate Plus index (EMIB).
4. ICE Index Platform, as of 30th August 2024. ICE BofA US Corporate Index (C0A0), ICE BofA Euro Corporate Index (ER00).
5. ICE Index Platform, as of 30th August 2024. ICE BofA  US Emerging Markets Liquid Corporate Plus Index (EMCL)
6. Swiss Re, as of July 2024. Sigma 3/2024 - World insurance: strengthening global resilience with a new lease of life
7. Reuters, as of 6th September 2024. “Fed’s Williams says time has arrived to start rate cuts”
8. Government of India, as of 30th August 2024. Press note on estimates of gross domestic product for Q1 (April to June) of 2024-24.
9. Nikkei Asia, as of 5th August 2024 “Indonesia’s economy grew 5.05% in Q2”
10. Fortune, as of 28th August 2024. “Thailand’s new prime minister inherits a US$14bn cash handout problem and a sluggish economy.”
11. Reuters, as of 14th August 2024 “Japan’s Prime Minister Kishida to resign, paving way for new leader”.
12. Business Times, as of 30th August 2024 “Singapore, Malaysia officials met to advance talks on Johor deal”
13. ING, as of 5th August 2024 “Turkey sees big drop in annual inflation on base effects, but July prices remain high”
14. BNN Bloomberg, as of 31st August 2024, “South African Finance Minister Says Stable Politics Buoying Rand.”
15. Bloomberg UK, as of 28th August 2024 “Ukraine’s bondholders approve US$20bn debt restructuring”
16. Reuters, as of 8th August 2024 “Brazil central bank will do ‘whatever is necessary’ to control inflation, director says”
17. Reuters, as of 26th August 2024 “Mexico’s next president taps energy academic to be Pemex chief”
18. WSJ, as of 8th August 2024 “Bank of Mexico cuts benchmark interest rate in split decision”
19. BBVA, as of 9th August 2024 “Peru Central Bank resumes rate cuts”

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of September 2024 and may change without notice.

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Index descriptions

EMGB - ICE BofA Emerging Markets External Sovereign Index tracks the performance of US dollar and euro denominated emerging markets sovereign debt publicly issued in the major domestic and eurobond markets.  Qualifying securities must have risk exposure to countries other than members of the FX-G10, all Western European countries and territories of the US and Western European countries.

EMCB - ICE BofA Emerging Markets Corporate Plus Index tracks the performance of the US dollar and euro denominated emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets. Qualifying issuers must have risk exposure to countries other than members of the FX G10, all Western European countries, and territories of the US and Western European countries.

EMIB - ICE BofA High Grade Emerging Markets Corporate Plus Index is a subset of the ICE BofA ML Emerging Markets Corporate Plus Index (EMCB) including all securities rated AAA through BBB3, inclusive.

EMHB - ICE BofA High Yield Emerging Markets Corporate Plus Index is a subset of the ICE BofA ML Emerging Markets Corporate Plus Index (EMCB) including all securities rated BB1 or lower.

Q690 - ICE BofA Custom Emerging Markets Short Duration Index tracks the performance of short-term US dollar and euro denominated emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets.

EMRA - ICE BofA Asia Emerging Markets Corporate Plus Index is the subset of the ICE BofAML Emerging Markets Corporate Plus Index, which includes only securities issued by countries associated with the region of Asia, excluding Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, and Uzbekistan.

EMHA – The ICE BofA High Yield Asia Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BB1 and lower with a country of risk within the Asia region.

EMIA -  The ICE BofA High Grade Asia Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Asia region.

EMRL - ICE BofA Latin America Emerging Markets Corporate Plus Index is a subset of The ICE BofA Emerging Markets Corporate Plus Index including all securities issued by countries associated with the geographical region of Latin America.

EMIL - The ICE BofA High Grade Latin America Emerging Markets Corporate Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Latin America region.

EMHL - ICE BofA High Yield Latin America Emerging Markets Corporate Plus is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated sub-investment grade based on the average of Moody's, S&P and Fitch, and with a country of risk associated with the geographical region of Latin America.

EMRE - ICE BofA EMEA Emerging Markets Corporate Plus Index is a subset of The ICE BofA Emerging Markets Corporate Plus Index including all securities issued by countries associated with the geographical region of Europe, the Middle East and Africa including Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan and Uzbekistan.

EMIE - ICE BofA High Grade EMEA Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Europe, Middle East and Africa regions.

EMHE - ICE BofA High Yield EMEA Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Europe, Middle East and Africa regions.

The MSCI EM Index is a free-float weighted equity index that captures large and mid cap representation across emerging market countries. The index covers approximately 85% of the free float-adjusted market capitalisation in each country.

LDMP - ICE BofA Local Debt Markets Plus Index is designed to track the performance of emerging markets sovereign debt publicly issued and denominated in the issuer's own currency.

J0A0 - The ICE BofA ML US Cash Pay High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt, currently in a coupon paying period that is publicly issued in the US domestic market.

C0A0 - The ICE BofA ML US Corporate Index tracks the performance of US dollar denominated investment grade corporate debt publicly issued in the US domestic market.

HE00 - The ICE BofA ML Euro High Yield Index tracks the performance of EUR dominated below investment grade corporate debt publicly issued in the euro domestic or eurobond markets.

ER00 – The ICE BofA ML Euro Corporate Index tracks the performance of EUR denominated investment grade corporate debt publicly issued in the eurobond or Euro member domestic markets.

CLCURFGB Index – Global Copper Refined Total Production - Yearly. This sector contains the copper production data for Chile, release by COCHILCO.

Important information

Muzinich and/or Muzinich & Co. referenced herein is defined as Muzinich & Co., Inc. and its affiliates. Muzinich views and opinions.  This material has been produced for information purposes only and as such the views contained herein are not to be taken as investment advice. Opinions are as of date of publication and are subject to change without reference or notification to you. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments and the income from them may fall as well as rise and is not guaranteed and investors may not get back the full amount invested. Rates of exchange may cause the value of investments to rise or fall. Emerging Markets may be more risky than more developed markets for a variety of reasons, including but not limited to, increased political, social and economic instability; heightened pricing volatility and reduced market liquidity.

Any research in this document has been obtained and may have been acted on by Muzinich for its own purpose. The results of such research are being made available for information purposes and no assurances are made as to their accuracy. Opinions and statements of financial market trends that are based on market conditions constitute our judgment and this judgment may prove to be wrong. The views and opinions expressed should not be construed as an offer to buy or sell or invitation to engage in any investment activity, they are for information purposes only.

This discussion material contains forward-looking statements, which give current expectations of future activities and performance. Any or all forward-looking statements in this material may turn out to be incorrect. They can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Although the assumptions underlying the forward-looking statements contained herein are believed to be reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurances that the forward-looking statements included in this discussion material will   prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation that the objectives and plans discussed herein will be achieved. Further, no person undertakes any obligation to revise such forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

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