Emerging Market Bond ETFs Are Worth a Second Look

After the recent sell-off in developing market assets, emerging market bonds and related ETFs look more attractive for income-minded investors.

Spreads and yields of certain emerging markets debt sectors are now higher than or are in-line with historical averages, according to Fran Rodilosso, Head of Fixed Income ETF Portfolio Management at VanEck. Local currency bond yields are now back above 3- and 5-year averages and are at their 10-year average, which includes both the financial crisis and taper tantrum over the period.

“One area we think is worth attention from a valuation perspective are bonds denominated in local currencies. Real interest rates, which are adjusted for expected inflation, are substantial due to the high nominal yields and inflation levels that remain controlled, in general. In comparison, developed markets real interest rates remain negative or near zero. Further, many currencies are near their lowest level versus the U.S. dollar in over a decade,” Rodilosso said.

Those who are wary of trying to catch a falling knife should keep in mind that emerging market debt should not be the main focus of a fixed-income portfolio. Rodilosso argued that investors should look to emerging market bonds as a way to help diversify their fixed-income exposure.

“Allocations should be sized to where an investor is comfortable, and managed so that a portfolio does not become overallocated to any single asset class. The typical advantages of emerging markets debt are its historically lower correlation to other asset classes, higher yield potential, and diversification opportunities. However, the higher volatility is a primary risk,” Rodilosso said.