Commodities Could Spark Emerging Markets Bond ETFs

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The recent weakness in the U.S. dollar and stronger EM currencies have helped bolster demand for emerging market assets, including local-currency debt this year. Add in rising commodities prices and the VanEck Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC) could be poised for more upside in 2018.

Emerging markets currencies are benefiting from the U.S. dollar’s disappointing performance this year, but even if the dollar rebounds, that move is expected to be gradual, indicating emerging currencies can whether incremental dollar strength. However, commodities prices could play an important role in charting EMLC's course this year.

“Commodity prices have been on a steady upswing since early 2016, rising over 40% through January 31, 2018,” said VanEck in a recent note. “Many investors, assuming a tight link between commodity prices and emerging market local currency returns, fairly view broad emerging markets exposure as a way to play the recovery in commodities.”

Commodities are a solid alternative to diversify a traditional portfolio of stocks and bonds. Commodities have historically acted as a good portfolio diversifier that zigs while traditional assets like stocks and bonds zag. Rising oil prices could help some of EMLC's geographic exposures. Last week, Standard & Poor's upgraded Russia's credit rating to BBB- from BB+, the ratings agency's first upgrade of Russia in over a decade.

“Currencies of oil exporters like Russia and Colombia have exhibited high correlations with oil prices over the past five years. The remaining 16 currencies generally experienced lower correlation, which is perhaps unsurprising given that over 60% of the index comprised net oil importers, as of January 31, 2018,” according to VanEck.

Bond investors may customize their credit risk exposure to emerging market debt through speculative high-yield options or more conservative investment-grade exposure, including the VanEck Vectors Emerging Markets High Yield Bond ETF (NYSEArca: HYEM), VanEck Vectors EM Investment Grade + BB Rated USD Sovereign Bond ETF (NYSEArca: IGEM) and VanEck Vectors Emerging Markets Aggregate Bond ETF (NYSEArca: EMAG).

“The overall moderate correlation of index returns with oil prices reflects the diversity of economies within the index. Despite rising commodity prices since 2016, the majority of emerging markets local currency bond returns over the past five years have been driven by local interest rates rather than currency appreciation,” according to VanEck.

For more information on fixed-income assets, visit our bond ETFs category.

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