The first interest rate cut of the year put fixed income investors on notice that the high-rate, high-yield environment they’ve been accustomed to is beginning to change. With that, emerging market (EM) bonds may be an option to consider when looking to diversify income and/or maximize yield potential.
This easing monetary policy adds another component to the market uncertainty that investors are already feeling. “Bond King” Jeffrey Gundlach confirmed the murky environment in a podcast with UBS.
“We have an environment that is highly unusual,” the DoubleLine CEO told UBS, noting that interest rates have been rising rather than falling. That’s a first-time occurrence in his 45 years as a professional investor.
A weakening dollar, however, creates opportunities in emerging market assets. Because EM assets are typically tied to the strength of their local currencies, a weakening greenback duly works in their favor. As such, Gundlach is tilting exposure to EM bonds.
“I might have a quarter of [an allocation to bonds], or least 20%, in local-currency emerging market bonds. Because you have much higher yields, you have better economics, you have better budget fundamentals,” Gundlach added.
That said, an ideal way to get EM bond exposure is via a fund like the Vanguard Emerging Markets Government Bond Index Fund ETF Shares (VWOB). It tracks the Bloomberg Barclays USD Emerging Markets Government RIC Capped Index. This gives investors broad exposure to this corner of the bond market. Because of the yield potential, it carries a high — but still relatively low — 0.15% expense ratio compared to its peers. With the additional risk premium comes the yield potential of the fund. It has a 30-day SEC yield of 5.76% as of September 30.
Alternate International Option
Fixed income investors who don’t want to accept the additional credit risk tied to EM bonds can opt for alternate international bond exposure that also adds developed markets. An ideal fund to consider in this scenario is the Vanguard Total International Bond Index Fund ETF Shares (BNDX).
BNDX tracks the performance of the Bloomberg Global Aggregate ex-USD Float Adjusted RIC Capped Index. Again, investors get a portfolio of investment-grade bonds to mitigate credit risk. Emerging market bonds get just over a 7% weighted exposure (as of August 31). So developed international markets remain the primary focus with the fund. True to form for Vanguard’s fixed income ETFs, it features a low expense ratio. That’s just 0.07%, or $7 per every $10,000 invested.
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