Investors seek to earning a little extra yield and diversify a portfolio should consider emerging market debt and bond-related exchange traded funds, especially as this fixed-income segment has been relatively overshadowed by developed market debt.
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A number of stars are aligning to help shine a light on emerging market debt, with low interest rates in the U.S., rising commodity prices and ongoing expectations of improving growth in developing economies.
Previous causes for concern have subsided. Notably, the Federal Reserve rate hike expectations have diminished after the Brexit vote as market observers argued that central bank policy makers would be loath to make changes in an uncertain post-Brexit world. Oil prices have recovered off their 12-year lows to around $50 per barrel, supporting many oil-heavy emerging economies. Additionally, China, the second largest economy in the world, appears to be stabilizing.
"EM debt has long offered attractive income, but weak fundamentals made it a somewhat risky proposition," BlackRock analysts, led by Richard Turnill, Global Chief of Investment Strategist, said in a research note. "We now see the asset class poised to benefit from the ongoing investor search for yield as three key headwinds to EMs have turned into tailwinds."
Emerging market debt also offers much more attractive yields after global investors piled into developed market debt in response to loose central bank policies, pushing yields toward record lows.
"Emerging market debt came into the year undervalued and some say there is more room to go," William Sokol, Product Manager of ETFs at VanEck, told ETF Trends in a call.
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For instance, Sokol said that emerging market debt spreads over U.S. government debt remain attractive and still hover above historical averages.
EM debt also trade at attractive valuations relative to U.S. corporate debt, providing an average 60 basis points more for the same volatility, Sokol added.
Fixed-income investors can tap into the emerging market through a number of ETF options. For instance, the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSE:EMB) and more recently launched the VanEck Vectors EM Investment Grade + BB Rated USD Sovereign Bond ETF (IGEM) provide exposure to U.S. dollar-denominated emerging debt securities, or developing country bonds issued in U.S. dollars. The USD denomination can help support these funds in case of a sudden appreciation in the greenback. EMB has a 4.58% 30-day SEC yield and IGEM has a 3.51% yield to maturity.
"Adding U.S. dollar-denominated investment grade emerging markets bonds to a global bond portfolio can add yield and diversification, without a significant increase in credit and currency risk," Sokol said.
While the emerging markets may be associated with greater risk, these bond ETF options include a mix of high-quality debt exposure, limiting potential credit risks. For example, EMB includes 2.2% investment-grade AA-rated debt, 11.9% A and 42.8% BBB. IGEM includes a slightly larger percentage of investment-grade exposure, with 2.1% AA, 16.7% A, 58.8% BBB.
With many emerging market central banks cutting interest rates amid lower inflation, the loose monetary policies should help support many local rates markets. Investors may also take a look at local currency-denominated ETFs, or emerging market bond ETFs that are issued in their local currencies, including the VanEck Vectors Emerging Markets Local Currency Bond ETF (NYSE:EMLC) and actively managed WisdomTree Emerging Markets Local Debt Fund (NYSE:ELD). The local currency emerging market bond ETFs come with slightly higher yields. EMLC has a 5.49% 30-day SEC yield and ELD has a 5.61% 30-day SEC yield.
Moreover, they have slightly higher credit qualities. EMLC includes 5.8% AAA, 3.0% AA, 28.5% A and 34.1% BBB. ELD holds 6.6% AAA, 9.5% AA, 35.2% A and 38.5% BBB.
However, with all investments that may produce higher returns, investors should be aware of the potential risks.
"We see hard-currency EM debt providing a more stable income stream than local currency options," Turnill said. "EM local debt may offer more upside, however, for those willing to accept currency risk."
This article was provided by our partners at etftrends.com.