In the ongoing search for yields during a stubbornly low-rate environment, conservative investors have turned to riskier emerging market debt securities and bond-related exchange traded funds to meet income needs.
Year-to-date, the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) attracted $857.6 million in net inflows, PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY) added $142.2 million and Vanguard Emerging Markets Government Bond ETF (NasdaqGM: VWOB) saw $124.7 million in inflows, according to ETF.com. [A Fundamental Approach to Emerging Markets Bonds]
Investors are likely funneling more money into the funds in search of yields. For instance, EMB has a 4.78% 30-day SEC yield, PCY has a 6.07% 30-day SEC yield and VWOB has a 4.59% 30-day SEC yield. In contrast, the yield on benchmark 10-year Treasuries is hovering around 2.38%.
Conservative pension funds and insurance companies have also taken notice of the attractive yield opportunity in the emerging markets and shifted into emerging debt as a way to bolster income to meet liabilities in a low yield environment.
“If you require, say, 5% a year in order to cover your insurance or pension liabilities, that is not available from developed market (debt) obviously,” Colm McDonagh, head of emerging market fixed income at Insight Investment, said in a Financial Times article.
Paolo Batori, global head of EM fixed income strategy at Morgan Stanley, projected a fundamental shift in market dynamic as about 5%, or $80 billion, invested by insurance companies and pension funds in European government bonds could switch over to emerging debt securities, or about double their current exposure.
The attractive emerging market bond yields, though, are not without their risks. For example, many fixed-income observers are closely watching the Federal Reserve’s monetary policy. A Fed rate hike could cause a large exit out of emerging market assets in favor of better returns in the U.S.
The emerging markets are also seen as a relatively risky area of the global market as well. Nevertheless, investors can still find high-quality emerging market bonds. For instance, EMB includes investment-grade debt rated AA 4.7%, A 10.9% and BBB 47.1%. PCY holds AA 4%, A 18% and BBB 35%. VWOB includes AA 11.0%, A 9.5% and BBB 50.8%. The higher quality tilt may help diminish some of the perceived risk with investing in the emerging markets.
For more information on the fixed-income market, visit our bond ETFs category.
Max Chen contributed to this article.