Borrowers and Lenders need to see the expansion of the Local Currency Corporate Bonds asset class Investors’ risk/reward profile would be enhanced by the introduction of the asset class in their portfolio Limited resources needed and tactical considerations also support the idea that this is a perfect moment to invest into this new business line

1. EM Corporate Bonds
in Local Currency
Author: Stefano Boschian-Pest sboschianpest@gmail.com +44 7774580919

2. Main conclusions
• Borrowers and Lenders need to see the expansion of the Local Currency
Corporate Bonds asset class
• Investors’ risk/reward profile would be enhanced by the introduction of the asset
class in their portfolio
• Limited resources needed and tactical considerations also support the idea that
this is a perfect moment to invest into this new business line

3. Contents
• Part I: Prospects for Local Currency Corporate Bonds
o The borrowers
o The lenders
• Part II: Local Currency Corporate Bonds and the EM Fixed Income space
• Part III: Asset Allocation
o Traditional EM Fixed Income indices
o The ML LOCL index
o Assumptions
o Portfolio optimization results
• Other considerations and conclusions

4. Part I
 Prospects for Local Currency Corporate Bonds
Will this asset class emerge ? The fact that it is needed by
borrowers and lenders, has not been enough until now. However
the evolution of the EM space is happening in stages, and this is
the next opportunity.

5. The borrowers
• The EM original sin applies to sovereigns as well as to EM corporates:
o Corporates are not able to borrow in their local currency
• $ lenders assume that borrowers will FX hedge. However:
o Carry is a big temptation for the borrower
o For different reasons, hedging is not always feasible
• $ borrowers assume that revenues will be a hedge. However:
o $ Revenues will shrink during a downturn
o At that point (the worst point in time), the $ liability will not be hedged
• Corporates need to borrow in Local Currency to reduce FX exposure

6. The lenders
• From a credit investor perspective:
o $ debt has the benefit of being easily distributable in the US, Europe and across the
globe. $ Savings and $ Reserves are everywhere.
o $ assets cannot be deflated by a local central bank
• Stuck in a suboptimal equilibrium: the marginal (credit) investor ideally wants to
lend in $ to a company which is mostly borrowing in local currency. This logic
typically bring us to an excess of $ debt.
• Local currency liabilities generally improve the credit quality of the company.
• Collectively, investors (locals and/or international) need to increase their lending
in local currency for the benefit of the credit quality of their portfolio.

7. Part II
Local Currency Corporate Bonds and the EM Fixed
Income space
Features of the chosen benchmark for the asset class

8. The EM Fixed Income Space:
outstanding amounts
• 70% of EM debit is corporate debt
• More than 75% of EM debit is LC
debt
• The development of a local asset
management and pension industry,
allowed EM sovereigns to increase
their local currency borrowing at the
expenses of hard currency debt.
Outstanding amounts in USD bn
(bn $)
Hard
Currency
Local
Currency
Total 1,670 11,350
Sovereigns 730 6,530
Corporates 940 5,820

9. Traditional EM Fixed income indices
Name Market cap Representation
JP Morgan’s EMBI Global
Diversified
US Dollar
denominated
Sovereign Bonds
$ 320bn 44%
JP Morgan’s CEMBI Broad
Diversified
US Dollar
denominated
Corporate Bonds
$ 270bn 28%
JP Morgan’s GBI-EM Core
(EMLC)
Local Currency
denominated
Sovereign Bonds
$ 925bn 14%

10. Potential growth for the Local Currency
corporate space
• Assets under management that are dedicated to EM are estimated to be
between 10% and 25% of the outstanding amounts of marketable obligations.
• The missing piece is the LC Corporate space, where the AuM is negligible
compared to the outstanding amount. Potential AuM is in the order of $ 600bn.
o An index was established only recently: Merrill Lynch Local Non-Sovereign Index
o The vast majority of bonds outstanding are targeting local investors
o A new format of bond, which attracts both onshore and offshore investors, is still
generally missing
o Ashmore, Bluebay, Aberdeen have launched funds dedicated to the asset class

11. The Merrill Lynch Local Currency Non-Sovereign
Index (LOCL) [1/4]
Created in Q4 2013 - Market cap $118bn, 177 issuers, 321 bonds
Rules:
• Include Corporate and Quasi-Government issuers (other than central banks and supranationals)
• Country of risk: Exclude issuers with a Developed Markets country of risk (FX G10, Western Europe,
Western European and US territories)
• Currency of denomination: Exclude: (i) FX G10 and Western European currencies, and (ii) currencies
with less than $10bn USD equivalent in outstanding nominal local currency sovereign debt. “Dual
currency” bonds are included.
• Maturity: Time to maturity at issuance ≥18 months; remaining time to maturity >= 1 month.
• No Sukuks
• Include only bonds that can settle through Euroclear
• Bond size filter: set in local currency terms, with a threshold between $75mm and $100mm
• Constituents are capitalization weighted with caps (Currency exposures are limited to 10% and
individual issuer exposures are limited to 2%)

12. The Merrill Lynch Local Currency Non-Sovereign
Index (LOCL) [2/4]
 Overlap with the CEMBI Index
Unclassified bonds:
• often issued by rated Issuers, leaving ~13% of
index risk being issued by unrated issuers
• Average FC-LT-Rating: BBB

13. The Merrill Lynch Local Currency Non-Sovereign
Index (LOCL) [3/4]
 Overlap with the CEMBI Index
Weight of top 10 LOCL names
Ticker Cosan
China
Resources
Land
Rurail
Gazprom
Bank
E/I Bank
Korea
Banco
Safra
Net4Gas
Housing &
Dev’ment
(SP)
RussAg Bogota
LOCL 2.17 2.13 2.08 2.06 2.05 2.05 2.05 2.03 1.99 1.99
CEMBI 0.12 1.95 0.39
Ticker Pemex Petrobras
E/I Bank
Korea
Hutchison
Whampoa
PDVSA Gazprom Codelco
American
Movil
Vale Itau
LOCL 1.96 2.05 1.94
CEMBI 4.47 4.12 1.95 1.72 1.71 1.64 1.57 1.50 1.49 1.45
Weight of top 10 CEMBI names
65% of LOCL is made of names
that do not belong to CEMBI

14. The Merrill Lynch Local Currency Non-Sovereign
Index (LOCL) [4/4]
 Overlap with the EMLC Index
LOCL EMLC
Duration 3.39 4.83
Yield to
Maturity
10.60% 6.41%
LOCL has larger exposure in Asia (~15%) than EMLC
A lower exposure to high yielding currencies like IDR is offset by overweight in BRL and RUB
LOCL constituents have a weighted average spread to Govies of around 460bps,
260bps excluding Odebrecht and OI

15. EM fixed income Indices: performance in USD

16. EM fixed income Indices: performance in
currency of denomination

17.  Asset Allocation: Assumptions and
Results
Investors can enhance their portfolio risk/reward profile
by introducing LC corporate exposure
Part III

18. Portfolio Optimization: Assumptions [1/3]
Expected Return and Volatility
Asset Class Expected Return Volatility Information ratio
EMBI 5.50% 6.80% 0.81
EMLC 6.40% 10.00% 0.64
CEMBI 5.30% 6.10% 0.87
LOCL 8.50%(*) 9.20% (**) 0.92 (**)
EMFX 3.00% 4.90% 0.61
The expected return of each asset class is the average
yield to maturity, with the exception of LOCL.
Volatility is annualized daily volatility over the period
May-2014 – May 2016

19. Portfolio Optimization: Assumptions [2/3]
Correlation Matrix (based on historical daily correlation, May 2014 – May 2016):
EMBI LEMBI CEMBI LOCL EMFX
EMBI 1.000 0.667 0.474 0.569 0.499
EMLC 1.000 0.341 0.760 0.700
CEMBI 1.000 0.508 0.470
LOCL 1.000 0.911
EMFX 1.000
• Correlation between CEMBI and LOCL is only 0.508. 0.406 can be attributed to corporate
credit risk, the rest being EM Sovereign risk.
• Correlation between CEMBI / EMBI (0.474 is significantly lower than correlation between
LOCL / EMLC (0.694). However, after removing FX risk from LOCAL and EMLC, their
correlation drops to 0.484 (see historical charts).
These numbers already suggest that CEMBI will be adding diversification benefits to an EM
Fixed income portfolio.

20. Portfolio Optimization: Assumptions [3/3]
In the following slides, optimal EM fixed income portfolios will. be constructed. The investible universe
will include traditional EM indices, the LOCL index and an FX hedge against local currency exposure.
The main inputs for the construction of an optimal portfolio are the indices’ expected returns, their
volatilities and correlations among themselves.
Adjustment factors for liquidity should be introduced so that the optimal portfolios
are not skewed towards riskier and less liquid asset classes (typically corporate bonds).
As the aim of this exercise to show how much should be invested into local currency corporates,
the conservative and simple approach that has been adopted is to adjust the LOCL volatility higher
and its expected return lower :
(*) LOCL expected return to 8.50% when average YTM is 10.60%
This is because we ignore two illiquid distressed bonds in BRL, OI & Odebrecht
(**) LOCL volatility: 3 scenarios have been run, using different volatility inputs:
• Scenario 1: historical volatility for the period May 2014 – May 2016 is 9.20% (vol-factor of 1.00x)
• Scenario 2: historical volatility stressed by a vol-factor of 1.10x (~10.20%)
• Scenario 3: historical volatility stressed by a vol-factor of 1.20x (~11.05%)

21. • Efficient frontiers with tree
different vol-factors (x1.00,
x1.10, x1.20)
Portfolio
Optimization:
Results [1/4]

22. • Efficient frontier and Asset
Allocation with
vol-factor = 1.00
Portfolio
Optimization:
Results [2/4]

23. • Efficient frontier and Asset
Allocation with
vol-factor = 1.10
Portfolio
Optimization:
Results [3/4]

24. • Efficient frontier and Asset
Allocation with
vol-factor = 1.20
Portfolio
Optimization:
Results [4/4]

25. Other
considerations
and conclusions

26. Which direction from here?
• The growth of the Local Currency asset class is telling us that:
o Global investors like local currency
o The chase for yield can push money out of $ into LC
• Institutional investors are more likely to close the gap between credit and local
currency:
o From a LC point of view: searching for yield enhancement through credit risk
o From a Credit point of view: abandoning the safe-haven of $ denominated debt
• Local and Supranational Regulators and Agencies are, at the same time,
pushing for local currency borrowing

27. What’s needed to start up this business?
• Seed funding in the USD 40-50mm range
• Assigning a dedicated PM to the fund management
• There are lots of synergies with existing EM credit and macro business:
• trading systems
• analytics
• execution
• relationships with sell-side
• in-house EM Credit analysts
• in-house EM Macro research

28. Conclusions
• This is a very good time to invest resources into the LC Corporate Bonds asset
class. EM Fixed Income is certainly not expensive. Not many buy-side forms
have a foot print in the asset class (Ashmore, Bluebay, Aberdeen). In 3 years
time, a track record in LC Corporates can be a meaningful advantage against
competition.
• Devoting resources now to this new business line is not only based on tactical
considerations. The development of LC Corporates is needed by investors and
borrowers. More importantly, this asset class represent an opportunity to
optimise investors’ portfolios risk/reward profile.

29. About myself, Stefano Boschian-Pest
• 10 years experience in emerging Market risk at Morgan Stanley
• Managed risk in the rates space (swap, FRAs, swaptions, basis swaps) as well
as in the credit space (sovereign bonds, CDS, corporate bonds, bond options)
• Responsible for a local currency corporate bond book with exposure to South
African corporates and Turkish financials

30. Thank you for your attention