Emerging markets bonds are trading modestly higher this year, lifting some of the related exchange traded funds. That includes the SPDR Bloomberg Barclays Emerging Markets Local Bond ETF (NYSEArca: EBND), which is up nearly 2% year-to-date.
EBND follows the Bloomberg Barclays EM Local Currency Government Diversified Index, a benchmark of bonds denominated in local currencies, meaning EBND stands to benefit if the dollar weakens following an impressive performance in 2018.
Some market observers have argued that the weakening U.S. dollar or strengthening emerging currencies helps remove a key risk for emerging market economies with large external debt burdens. Since many emerging debtors borrow in U.S. dollar-denominated debt, a stronger greenback would raise borrowing costs or tighten a developing economy’s financial conditions.
A stabilizing dollar outlook also diminishes the danger of taking on emerging currency exposure, which has historically acted as a large source of volatility for investors investing in local-currency-denominated emerging market debt.
“Going back to 2000, the median differential between the high yield bond yield-to-worst and the emerging market debt yield-to-worst is at about 1.27,” said State Street in a recent note. “Right now, that difference is 1.09, indicating that EM debt is trading nearly on par with high yield debt—despite the fact that EM debt is 80% investment grade versus all speculative grade for high yield.”
Inside EBND ETF
EBND, which is more than eight years old, holds 370 bonds and has option-adjusted duration of 5.43 years. Over 61% of its holdings are rated A or Baa.
EBND’s underlying index “index includes government bonds, in local currencies, issued by investment grade and non-investment grade countries outside the U.S. that have a remaining maturity of one year or more,” according to State Street.
South Korea, Brazil and Malaysia are EBND’s largest geographic exposures, combining for nearly a third of the fund’s weight.
“An emerging market debt position may introduce sovereign and currency risk,” said State Street. “However, a continued patient stance from the Fed and a docile dollar, as shown by implied currency volatility sitting near three-year lows, may alleviate some of those concerns.”
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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.