Emerging market bond ETFs have strengthened this year and the asset category may still have legs.
“With strong emerging markets local currency bond returns this year thus far and institutional emerging markets FX exposure at a post-crisis high, according to J.P. Morgan, investors may be asking whether there is still room for additional returns in the asset class. We believe there is,” Fran Rodilosso, Head of Fixed Income ETF Portfolio Management for VanEck, said in a research note.
The J.P. Morgan GBI-EM Global Core Index increased 13.9% year to date through September. Rodilosso argued that local interest rates, which include both carry and price movements from changes in local interest rates, contributed to 8.1% of that total return while currency appreciation accounted for 5.4% of the return.
Regional differences also helped offset some other areas of weakness. For instance, Asian, Latin American and Middle East/African countries experienced strong rate performance. Meanwhile, European currencies have returned almost 12% and contributed to over 50% of overall currency returns on local currency bonds.
European emerging market currencies like the Polish zloty, Hungarian forint and Czech koruna, which benefited from their close ties to the euro currency and ongoing growth in the Eurozone, were among the major contributors to emerging market bonds.
Related: Emerging Market Bond ETFs Offer Attractive Yield Opportunities
However, Rodilosso warned that the recent rebound in the U.S. dollar may pose a risk to the gains if the greenback continues to appreciate.
“With improving economic growth and controlled inflation, fundamentals appear to remain supportive for emerging markets currencies. Given that there has not been a broad-based rally this year, we believe that the asset class is not overbought and there may be room for additional appreciation. Further, emerging markets local currency bond yields remain attractive,” Rodilosso added.
Investors interested in gaining exposure to emerging market local currency bonds for their attractive yield potential may turn to options like the VanEck Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC), which tracks the J.P. Morgan GBI-EM Global Core Index, which includes decent exposure to European emerging markets include 9.1% Poland, 3.8% Hungary and 3.2% Czech.
Furthermore, bond investors may customize their credit risk exposure to emerging market debt through speculative high-yield options or more conservative investment-grade exposure, including the VanEck Vectors Emerging Markets High Yield Bond ETF (NYSEArca: HYEM), VanEck Vectors EM Investment Grade + BB Rated USD Sovereign Bond ETF (NYSEArca: IGEM) and VanEck Vectors Emerging Markets Aggregate Bond ETF (NYSEArca: EMAG).
For more information on the fixed-income market, visit our bond ETFs category.