Yield-hungry investors are widely embracing emerging markets fixed income exchange traded funds this year, including local currency fare, such as the VanEck Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC). Some market observers believe that trend is likely to continue in 2018.
EMLC, which tracks the J.P. Morgan GBI-EM Global Core Index, has a 30-day SEC yield of 5.88%. That is well above what investors find on traditional aggregate bond funds, which are usually lightly allocated to emerging markets debt. Even with that tempting yield, over 56% of EMLC’s holdings carry investment-grade ratings.
“Despite the relatively recent explosive growth of ETFs in general, these vehicles still make up only a small part of the overall emerging markets debt market,” according to VanEck research. “According to Morningstar, there is approximately $500 billion in emerging markets debt managed assets globally. ETFs comprise less than 10% of this total and a similar proportion of such assets managed in the U.S. However, investor flows tell a different story. Year-to-date through October, ETFs garnered 23% of net inflows into the asset class globally and 49% in the U.S.”
Emerging markets currencies are benefiting from the U.S. dollar’s disappointing performance this year, but even if the dollar rebounds, that move is expected to be gradual, indicating emerging currencies can whether incremental dollar strength.
Emerging market fundamentals, like growth, debt stock, real rates and policy flexibility, all remain at a favorable starting point relative to developed economies going forward.
“There are other reasons why we believe that ETFs are particularly well suited for emerging markets debt investors,” according to VanEck. “Emerging markets debt has gained greater acceptance over the past decade as a standalone asset class, separate from a global bond allocation, among asset allocators. For this group of investors, ETFs provide low cost, transparent, and liquid beta exposure. Although ETFs are increasingly being used as part of a strategic asset allocation, perhaps as a complement to actively managed strategies, they are also used tactically by investors.”
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 fixed-income assets, visit our bond ETFs category.