Spreads Say This Bond ETF Is Beckoning | ETF Trends

With interest rates at historic lows in the U.S., fixed income investors should do some globe-trotting in search of higher yields. The VanEck Vectors EM High Yield Bond ETF (NYSEArca: HYEM) is an idea to consider.

HYEM seeks to replicate the ICE BofAML Diversified High Yield US Emerging Markets Corporate Plus Index, which is comprised of U.S. dollar-denominated bonds issued by non-sovereign emerging market issuers that have a below investment grade rating and that are issued in the major domestic and Eurobond markets.

The $432.1 million HYEM has a 30-day SEC yield of 5.90%, which means the ETF is lobbing off a higher level of income than equivalent domestic bond funds. In fact, spreads on emerging markets debt indicate now would be a good time for investors to give EMLC a look.

“Compared with most other emerging markets debt sectors, high yield corporates have held up remarkably well,” notes VanEck head of fixed income Fran Rodilosso. “Although returns are still slightly negative year to date (-1% as of July 31, 2020), this represents significant outperformance versus high yield emerging markets sovereigns, which are down nearly 7% due to severe distress that several lower rated and financially weak countries have experienced following the onset of the pandemic.The default rate among emerging markets high yield sovereigns has already exceeded 16% year to date, compared with only about 2% among high yield emerging markets corporates, according to J.P. Morgan (as of June 9, 2020).”

Hyping Up HYEM

Investors jumping back into the murky waters of emerging markets (EM) is a positive sign for the capital markets as it portends to the risk dial being turned a few notches higher. EM assets like bonds were viewed with distaste amid the height of the pandemic, but investors are slowly warming up to EM bonds again.

“In addition to the higher quality tilt, we believe there are several differences that may make emerging markets high yield an attractive part of a global high yield bond portfolio. To the extent the impressive recovery in China continues, we believe China issuers will likely remain among the largest contributors to performance in the index,” according to Rodilosso.

Other factors, including better performing energy debt relative to the U.S. and a rising number of higher quality fallen angel bonds, bolster the case for HYEM.

“Although exposure to energy issuers is approximately equal to the broad U.S. high yield market, emerging markets issuers within this sector have significantly outperformed,” writes Rodilosso.An increase in fallen angels, whether driven by weaker standalone fundamentals or sovereign downgrades, may also benefit returns for emerging markets corporates going forward. Including Pemex, there have been more than $80B of emerging markets fallen angels by market value in 2020, and we believe there is high potential for further downgrades over the next 12 months.”

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.