High-yield corporate fixed income securities and emerging markets debt are two investment sectors that stand out for delivering positive returns amid global equity market uncertainty and volatility. Although the sectors are not closely correlated in terms of performance - debt issued by companies is naturally priced on a different basis to sovereign or other emerging markets debt - some fund managers group them together because they share a particular flavour many investors are looking for. Both sectors consist of paper below investment grade, so they are risk assets which offer the potential of good returns. Investors have been increasing their exposure to the two sectors over the past six to eight months, according to Peter Wilby, senior portfolio manager with Citigroup Asset Management. Mr Wilby is responsible for investment policy and strategy for Citigroup's emerging markets debt and high-yield fixed income portfolios. Citigroup Asset Management manages about US$$6.5 billion in emerging markets debt and US$7.5 billion in high-yield fixed income. The investors are a mix of retail investors, pension funds and large global organisations. 'To put it bluntly, emerging market debt and high-yield bonds are global junk - anything below investment grade around the world that borrows,' Mr Wilby said. 'We like both high-yield and emerging markets debt, but we are a little more confident in our outlook for high yield. We favour the United States high-yield market a little bit more because I think it has a lower downside than the emerging markets. Emerging markets, unfortunately, are a little overly dependent on Brazil right now.' Although Citigroup believes Brazil will recover from its financial problems, it sees a risk of any serious blowout there spreading negativity among investors in other emerging markets. 'Brazil needs a decent global environment to survive. Its cost of capital is such a large component of its credit-worthiness because it is very heavily funded with short-term debt.' Mr Wilby said the world is in a global credit crunch, where net borrowers - whether they are nations or companies - are punished in the markets with relatively lower valuations and higher borrowing rates than in more normal times. 'Capital-intensive companies like cable television operators are suffering along with capital-intensive countries like Brazil because they are large net borrowers. We are basically of the belief that that differential is going to come down, so we have rotated our portfolios towards the net borrowers.' Citigroup has a reasonably positive outlook for the global economy for the next 12 months, which adds to the argument for investing in high-yield and emerging markets debt; if stock markets start roaring ahead, direct equity investment makes far more sense. 'We were bearish on the economy starting in 1999, so we have had relatively strong performance in credit risk markets because we did not buy the whole telecommunications asset class. We were very risk averse, although we did not quite expect it to blow up as it did. We have been fairly conservative in our economic outlook.' Mr Wilby said Citigroup saw the two main risks in the US market as a slump in the telecoms sector or a collapse in US consumer sentiment. History delivered the bursting of the telecoms bubble, but the US consumer had been bailed out by lower interest rates. He said investors had been moving in to the high-yield and emerging markets sectors without any major marketing push. Nonetheless, investment in the sectors aligned with the bank's interpretation of global trends, and its perception that assets in both the high-yield and emerging markets sectors had become undervalued. 'You have a very high corporate credit stress over the past few years, notably in the examples of WorldCom and Enron, but it has gone way beyond that. Our view is most of it has now washed through the system.' Corporate bond yields were likely to benefit from a change in the corporate capital-raising environment. With equity capital harder to raise and prospects for global growth unexciting, companies had incentive to improve their balance sheets, which favoured lenders versus equity providers, Mr Wilby said. 'The corporate bond holder is kind of in the driver's seat right now.' Emerging market debt, while not as attractive as corporate high-yield paper, was also ripe for an upward revaluation, he said. 'There are very high levels of relative spreads in emerging markets because there has been a flight to risk-averse securities. It is the most volatile fixed income market in the world, so I think the valuations are very compelling. When you have cheap valuations - high yields from a fixed income point of view - you don't need a fabulous global environment, what you need is just an OK one. If you have an OK outlook, combined with the high spread, it makes for an attractive case.' The returns from Mr Wilby's funds had far exceeded their benchmark returns since they were established in the 1990s. In high yield, his fund returned 9.49 per cent per year against the benchmark US High Yield - Core Composite index's 6.65 per cent. His emerging market debt fund returned 18.68 per cent compared with the benchmark's 14.35 per cent. Graphic: profilgwz