If we’re looking to find blood, we’re going to want to find something that marries the unholy trinity of current market scorn: (1) emerging markets, (2) high yield, and (3) anti-dollar.
Say hello to emerging market local currency bonds – conveniently packaged in ETF format in State Street’s SPDR Barclays Emerging Markets Local Bond ETF “EBND.”
History seems to be on the side of buying high yield sovereign debt. In a new white paper, Mebane Faber demonstrates that weighting global debt towards higher yields can significantly increase total return. We would argue that much of this premium likely comes from the contrarian, value tilt that such a strategy would take on.
Which is, arguably, exactly what makes emerging market local currency debt so attractive today. In Research Affiliates’ published 10-year expected risk and return tables, Emerging Market Local Currency debt is one of the highest expected returning asset classes – with expected yield and currency appreciation as the primary return sources.
Of course, buying into a contrarian, value play can lead to significant short-term pain since valuations sometimes get worse before normalizing. At Newfound, we prefer to embrace a momentum-based methodology to help us allocate when we feel the risk of further significant loss has subsided. For those looking to build a more significant strategic allocation, however, a dollar-cost averaging approach over multiple quarters may be well suited.
Whatever the approach, we believe that emerging market local currency debt is worth evaluating: you won’t find streets much bloodier than these.
Corey Hoffstein is the Co-founder & CIO at Newfound Research, a participant in the ETF Strategist Channel.