With investors thirsty for yield and income, low and negative-yielding developed world sovereign bonds, while safe, are increasingly unappealing for income-generating purposes. Conversely, exchange traded funds, such as the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) and the Market Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC), are appealing thanks to their significantly higher yields.
In fact, the recent growth of EMB, the largest ETF tracking emerging markets debt, has been staggering. EMB tracks the J.P. Morgan EMBI Global Core Index, a market-cap-weighted index. Potential investors should note that since it is a cap-weighted index, countries with greater debt will have a larger position in the portfolio.
Related: 3 Bond ETFs Hinting at Emerging Markets Upside
With interested rates expect to remain lower in the developed world and perhaps decline further, some strategists see emerging markets sovereign debt as a prime destination of income-starved investors.
[related_stories]“We expect lower rates ahead, with the Bank of England set to cut interest rates soon, U.S. rates on hold and potential for further quantitative easing in the UK, eurozone and Japan. We believe there’s limited scope for monetary policy to reflate the global economy, however, and much-needed fiscal stimulus and structural reform progress looks unlikely over the coming months,” according to a BlackRock note posted by Dimitra DeFotis of Barron’s.
According to BlackRock, emerging market governments have accumulated less dollar debt, built up foreign reserves and adopted flexible exchange rates to obviate mistakes during the 1980s and 1990s crises. Though the current outlook for emerging markets debt is far from sanguine, some analysts see opportunity in the asset class.
Related: The Case for Emerging Markets Bond ETFs
The Federal Reserve’s refusal to boost interest rates is also helping emerging markets bond ETFs. Previous Fed rate hikes have triggered volatility in the emerging markets. While many emerging markets have garnered a bad reputation for experiencing spiraling debt defaults in face of rapid currency depreciation, the developing economies are more resilient in a weak commodities environment.
“We prefer high yield hard-currency debt, but are cautious on commodity exporters. We like local-currency debt in Brazil, India, Indonesia and Poland for those who can stomach volatility,” adds BlackRock in the note posted by Barron’s.
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iShares J.P. Morgan USD Emerging Markets Bond ETF
Tom Lydon’s clients own shares of EMB.