Exchange traded funds holding emerging markets debt have been among this year’s more impressive asset classes. That after a year in which dollar-denominated funds such as the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) to local currency fare such as the Market Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC) were decked by fears of rising interest rates in the U.S.
Investors’ thirst for yield and a cooperative Federal Reserve, which still has not raised interest rates in 2016, are among the reasons emerging markets debt is one of this year’s hottest asset classes.
Enticing greater investment dollars, economic fundamentals and idiosyncratic risks in the emerging markets are improving, such as rising oil and commodity prices that are supporting major emerging economies, like Brazil and Russia. Additionally, concerns over China downturn, which drove bearish positions last year, have diminished.
Related: Emerging Markets are Hot for Bond ETF Investors
Data suggest some institutional asset managers, including asset allocation strategists, pension funds, and foreign fund managers, are now increasing exposure to emerging markets in various ways, including via bond funds. In fact, EMB is now the world’s largest emerging markets bond fund of any kind, including mutual funds.
“Emerging market assets are typically vulnerable to Fed rate hikes. Higher U.S. rates often buoy the U.S. dollar and weigh on commodity prices. Yet the reaction to the next rate rise could be muted. We expect the Fed to raise rates just once this year − likely in December − and to proceed cautiously given the unevenness of the domestic economic recovery, as highlighted by the weak retail sales data last week, and global growth uncertainties,” according to a BlackRock note posted by Dimitra DeFotis of Barron’s.
Market observers argue that the emerging market debt outlook looks more favorable as commodity prices, notably oil, seem to have stabilized and economic activity in some key developing countries begin to rebound.
Related: 3 Bond ETFs Hinting at Emerging Markets Upside
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.
“The lower for longer outlook for Fed rates extends investors’ reach for yield. It also buys time for EMs to implement structural reforms, such as India’s recent tax reform and Indonesia’s renewed push for fiscal reform. This could enable select EMs to be more resilient when the Fed eventually normalizes rates. We like EM debt, where spreads remain attractive, and are neutral on EM equities. We prefer domestically oriented stocks and EMs with reform momentum,” adds BlackRock in the note posted by Barron’s.
For more information on the fixed-income market, visit our bond ETFs category.
iShares J.P. Morgan USD Emerging Markets Bond ETF
Tom Lydon’s clients own shares of EMB.