High-Yield Emerging Market Bond ETFs Come with Risk
June 4th 2012 at 8:00am by Tom Lydon
As income hunters take a more creative approach to eke out more yield, investors have increasingly turned to international debt and bond exchange traded funds. However, they need to remember that the higher yields also go hand-in-hand with added risks.
With most U.S. bonds at historic low yields, the outlook for potential capital gains in the U.S. bonds and related ETFs has greatly diminished, writes Dan Caplinger for the Motley Fool.
Meanwhile, rates offered in the other corners of the world look much more attractive. For instance, Australia’s three-month bond yields are over 3%, whereas U.S. 3-month Treasury bond yields are less than 0.1%. In emerging market Brazil, long-term bonds in the five- to nine-year maturity range provide yields close to 10%, compared to the 5-year U.S. Treasury yield of 0.75%.
High yields provide bond investors with two main benefits: Obviously, an individual will receive a higher current income from the investment. Additionally, the high rates have greater room to fall, which is not necessarily a bad thing since the value of the bond is inversely related to yield – if yields drop, bond prices rise.
However, with foreign bond funds, like the WisdomTree Emerging Markets Local Debt (NYSEArca: ELD), investors may be exposed to currency risks. The funds are denominated in the issuing country’s local currencies, which leaves the investor exposed to fluctuations in the currency market. While the U.S. dollar has been strengthening, there is no guarantee that this trend will continue. Currencies typically follow a cyclical trend, instead of the long-term growth trend found in equities. [Emerging Market Bond ETFs that Hedge Currency Risks]
For more information on international sovereign debt, visit our international Treasury bonds category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.