The iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) and other emerging markets bond exchange traded funds continue to entice investors seeking additional sources of yield beyond investment-grade U.S. debt and there are good reasons why this asset class could see more near-term growth.
While yields in developed economies remain depressed, with some even trading with negative yields, emerging market bonds have quickly gained traction as one of the few areas left with attractive yields.
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.
There are “interesting opportunities for taking credit risk in selected emerging markets, particularly in markets such as Brazil and Mexico, where rates could come down. Compared to 20 years ago—or even just 10 years ago—emerging markets are in much better shape,” according to a recent BlackRock note.
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.
If the Federal Reserve hikes rates, emerging market companies that borrowed overseas are more susceptible to foreign capital swings and could find it more difficult to refinance debt. Moreover, a strengthening dollar makes it costlier to pay off dollar-denominated bonds, but that scenario may not be as worrisome today as it was several years ago.
“Their reserves are higher, their leverage is lower, and they are relatively cheap compared to other parts of the world. Monetary policy has pushed rates in Europe to extremely low levels, which has pulled down global interest rates to distorted levels. But emerging markets have actually not been tethered to European rates,” said BlackRock.
Alternatives to EMB include the PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY), VanEck Vectors Emerging Markets Aggregate Bond ETF (NYSEArca: EMAG), VanEck Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC), SPDR Bloomberg Barclays Emerging Markets Local Bond ETF (NYSEArca: EBND) and iShares Emerging Markets Local Currency Bond ETF (NYSEArca: LEMB).
For more information on the fixed-income market, visit our bond ETFs category.
Tom Lydon’s clients own shares of EMB.