With interest rates still low by historical standards throughout the developed world, income-seeking fixed income investors are embracing alternatives to traditional government debt. That includes emerging markets bonds and the related ETFs, such as the iShares J.P. Morgan USD Emerging Markets Bond ETF (NASDAQ: EMB).
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. EMB is now the world’s largest emerging markets bond fund, ETF or mutual fund.
“We like selected EM debt for income and potential price appreciation amid low inflation and subdued currency volatility in the emerging world,” said BlackRock in a recent note. “EM debt also gleans support from synchronized global growth, buoyant commodity prices and global investor thirst for yield.”
EMB, which holds 385 bonds, has a 30-day SEC yield of 4.4% and an effective duration of almost 7.3 years. Duration measures a bond’s sensitivity to changes in interest rates. The iShares Emerging Markets Local Currency Bond ETF (NYSEArca: LEMB) shows a 5.56% 30-day SEC yield. That ETF could be poised to thrive if the dollar remains sluggish.
“Stronger EM currencies have boosted the performance of EM local-currency debt this year,” according to BlackRock. “We see the U.S. dollar appreciating only modestly and gradually—and not diluting the EM investment case. So what are the main risks? A stalling of global growth momentum, a yield spike caused by slowing monetary stimulus, or a rapidly resurging dollar.”
Related: 3 Bond ETF Strategies for a Rising Rate Environment
“Emerging markets last year ran their first aggregate annual current account deficit (CAD) for 17 years – and their largest since 1998 (both in US dollars and as a percentage of GDP). The deterioration has been driven mainly by a drop in commodity prices, a narrowing in China’s surplus, and the effect of abundant global liquidity conditions. We forecast the aggregate EM CAD will widen further in 2017 to its highest level in US dollar terms since at least 1990,” according to Fitch Ratings.
The largest country exposures in EMB are Mexico, Indonesia, Turkey and Russia. Over 61% of the ETF’s holdings are rated BBB or BB.
For more information on the fixed-income market, visit our bond ETFs category.
Tom Lydon’s clients own shares of EMB.