Even amid concerns about U.S. monetary policy, emerging markets bond exchange traded funds, such as the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) have been decent performers this year, a trend some market observers believe will continue as investors keep looking for higher yielding assets.
Emerging currencies have strengthened on improving commodity prices, notably the rebound in crude oil prices, as many developing economies are major exporters of raw materials. Consequently, more investors are looking to emerging market yields, despite the risks associated with the developing economies.
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.
“As fundamentals improve and fund flows continue, we see value in high-yielding local bonds, such as those in Brazil, India and Indonesia, where real yields look attractive,” according to a J.P. Morgan Asset Management note posted by Dimitra DeFotis of Barron’s.
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. The Fed raised rates earlier this month, marking the third time it has done so in the past 15 months.
The VanEck Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC) is another compelling idea among emerging markets bond ETFs.
EMLC, which holds bonds denominated in local currencies, allocates about 23% of currency weight to bonds from Central and Eastern European issuers. Mexico is that ETF’s largest country weight, followed by Poland.
“Key currencies have strengthened as the U.S. dollar has weakened on a trade-weighted basis—in particular, the Mexican peso, which has moved from extreme to moderately cheap levels,” according to the J.P. Morgan note seen in Barron’s. “Despite these recent moves, local currency bonds remain attractive, particularly those offering high real yields and where the market is under-pricing the rate cutting cycle. In Brazil for example, where the real yield on the 10-year local bond is close to 5.25%, the market is only expecting interest rates to be cut by 200 basis points (bps) compared to our expectation for a 350 bps reduction.”
For more information on the fixed-income market, visit our bond ETFs category.
Tom Lydon’s clients own shares of EMB.