Bonds have regained their momentum this year, but after a multi-year run, many traditional fixed-income assets look pricey or overvalued. Alternatively, investors may consider opportunities in exchange traded funds (ETFs) that track emerging market debt.
Investors may be attracted to the cheaper valuations and wider yield premiums that emerging market bonds offer over safe-haven government debt, especially with yields on benchmark 10-year Treasuries dipping back toward historical lows this year.
Moreover, emerging market assets as a whole remain depressed to developed markets. Consequently, the unloved area may have already priced in most of the negatives that have previously pressured the market.
While many emerging markets have a bad reputation for spiraling debt defaults in face of rapid currency depreciation, the developing economies are more resilient than many would expect. The developing economies are typically associated with greater risks, but many emerging countries hold investment-grade debt ratings through sound financial management.
Additionally, emerging market governments have accumulated less dollar debt than the spendthrift U.S., built up their foreign reserves and adopted flexible exchange rates to obviate mistakes made during the 1980s and 1990s crisis.
The emerging market bond asset category also provides a good diversifer for traditional bond and stock investment portfolios. Emerging market debt has exhibited low correlations to both U.S. equities, Treasuries and corporate debt.
The attractive emerging debt yields, though, are not without their risks. 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 safer returns in the U.S.
Fixed-income investors can diversify into emerging market through a number of ETF options. For instance, the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) and PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY) 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.[related_stories]