Many observers anticipate interest rates will remain depressed or lower for longer, especially with markets projecting the Federal Reserve to only slowly raise rates two more times this year. Consequently, fixed-income investors are diversifying and seeking out areas of greater yields, such as emerging market debt and bond-related exchange traded funds.
“Investor demand for emerging market (EM) debt has been strong lately, as the near-term risk of trade wars has faded and income seekers have flocked to the asset class’ higher yields,” Richard Turnill, BlackRock Global Chief Investment Strategist, said in a note.
Emerging market debt funds experienced 12 consecutive weeks of inflows, the longest streak since the U.S. elections, according to EPFR Global data for the week ended April 19.
“Many investors who had been scared off the asset class in the months following the U.S. presidential election moved back in,” Matthew Tucker, Head of iShares Americas Fixed Income Strategy said in a note. “Initial concerns that protectionist policies could hurt EM economies and investments abated after the new administration stepped into office. As a result the category has done surprisingly well since the start of the year: $3.4 billion has come into EM bond ETFs, and the J.P. Morgan EMBI Global Core Index has returned a robust 5.17%.”
Investors interested in emerging market bond exposure may consider a number of ETF options, such as the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB), 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).
“However, it’s important for investors to remember that not all EM debt is created equal,” Turnill warned. “We see selected opportunities in the asset class, especially in local-currency debt among broadening reflation and limiting risks from U.S. dollar appreciation, but high valuations keep us neutral overall.”
Emerging market debt have suffered more from their forex exposure than emerging market equities, William Sokol, Product Manager of ETFs at VanEck, told ETF Trends in a call.
“We have witnessed that foreign exchange currency moves, or forex risks, have affected emerging market bond returns,” Sokol said.
Fran Rodilosso, Head of Fixed Income ETF Portfolio Management at VanEck, explained that the greater effect forex exposure has emerging debt may be attributed to how the underlying indices weight holdings as many leading emerging market debt indexers do not consider Hong Kong, Taiwan and Korea to be emerging markets, which means that they have less emerging Asia exposure.
Consequently, emerging market debt investors have more exposure to countries with commodity dependency and who currently have flexible currency regimes, notably a heavier emphasis on emerging Latin American debt.
“If you are bullish on commodities or believe in the reflation story, then local currency emerging market debt may provide an attractive way to express that view and have more room to go,” Sokol said.
Looking at the previously mentioned emerging bond ETF options, investors who are more bullish on the U.S. dollar may lean toward U.S.-dollar denominated emerging bond options, such as EMB, which has a 4.62% 30-day SEC yield; PCY, which has a 5.04% 30-day SEC yield; and EMAG, which has a 4.11% 30-day SEC yield.
On the other hand, investors can turn to the local currency-denominated emerging bond ETF options, such as the EMLC, which has a 5.79% 30-day SEC yield; EBND, which has a 5.03% 30-day SEC yield; and LEMB, which has a 4.78% 30-day SEC yield.