Investors who want to bolster their income portfolios and generate a little extra yield should consider emerging market bond exchange traded funds.
Some, though, may be loath to diversify into emerging market debt, associating the developing economies with higher risks. However, these markets also offer bonds with relatively low credit risks.
“While some investors view emerging markets bonds as equivalents to high yield bonds, about half of the broad U.S. dollar-denominated sovereign market (as represented by the J.P. Morgan EMBI Global Diversified Index) is rated investment grade,” William Sokol, Product Manager of ETFs at VanEck, said in a note.
For example, the VanEck Vectors EM Investment Grade + BB Rated USD Sovereign Bond ETF (NYSEArca: IGEM), which provides exposure to U.S. dollar-denominated emerging debt securities or developing country bonds issued in U.S. dollars, primarily covers investment-grade debt. IGEM’s credit quality break down includes AA 2.8%, A 16.9% and BBB 59.2%, along with 19.8% non-investment grade BB-rated debt.
SEE MORE: Emerging Markets are Hot for Bond ETF Investors
While lower quality debt typically generates higher yields, investment-grade emerging market debt also provides some attractive payouts – IGEM comes with a 3.07% 30-day SEC yield. The higher yields out the developing markets may reflect the idiosyncratic risks associated with the regions, such as commodity price exposure and political risks, among others.
[related_stories]However, investors should be aware of the risks if things seem too good to be true. For instance, Sokol pointed out that Venezuela had an average yield of approximately 26% as of July 31, 2016, but the distressed levels reflect the economic and political risks that the emerging economy is still tackling with.
“Therefore, the very real possibility of default puts the ability of realizing this substantial yield in question,” Sokol said.
SEE MORE: Emerging Market Bond ETFs are Still Alluring
On the other hand, higher quality emerging market debt has generated lower annualized total returns, but the investment-grade debt also showed substantially lower volatility, providing more attractive risk-adjusted returns over the long haul.
“Overall, investors who maintained exposure to investment grade emerging markets sovereign bonds, with an allocation to BB-rated bonds or 20%, would have earned 7.55% over the past ten years versus 7.83% on the broader emerging markets sovereign index, with lower volatility and higher risk-adjusted returns as measured by the Sharpe ratio,” Sokol added.
For more information on the fixed-income market, visit our bond ETFs category.