Emerging market bonds and related exchange traded funds now offer higher yields with a lower duration than U.S. speculative-grade debt, potentially providing income-minded investors an attractive alternative in a stubbornly persistent low-yield environment.
In a research note, Fran Rodilosso, Head of Fixed Income ETF Portfolio Management at VanEck, pointed out that emerging markets high yield bonds offered a 90 basis point yield pickup as of June 30 with a lower duration and a higher average credit quality, compared to U.S. junk bonds.
Duration is a measure of a bond fund’s sensitivity to changes in interest rates. High-yield EM debt shows a 3.75 year duration, compared to U.S. junk bond’s 4.04 year duration.
Additionally, about 60% of the emerging markets’ high yield index is rated BB- or higher, compared to less than 50% in the U.S. speculative-grade debt market.
All in all, Rodilosso painted a picture where fixed-income investors may find more attractive yields with lower credit risk when looking into emerging market speculative grade debt over U.S. high-yield bonds.
More investors are beginning to realize the benefits of diversifying into emerging market high yield debt. Over the past decade, the EM high-yield bond market has expanded to $440 billion as of June 30 from $56 billion at the end of 2007. Along with its growing size, investors have gained access to a more diverse exposure of 339 issuers in 48 countries.
“The quality and diversification help to explain why default rates in emerging markets corporates have been lower on average than in U.S. corporates. And because the bonds are denominated in U.S. dollars, investors are not taking on additional currency risk in their portfolios,” Rodilosso said.
Investors who are interested in emerging market high-yield bond exposure can take a look at something like the VanEck Vectors Emerging Markets High Yield Bond ETF (NYSEArca: HYEM), which tracks the BofA Merrill Lynch Diversified High Yield US Emerging Markets Corporate Plus Index. The ETF holds a number of U.S. dollar-denominated bonds issued by non-sovereign emerging market issuers that are rated below investment grade, offering investors attractive yields. HYEM comes with a 5.73% 30-day SEC yield and a 3.60 year duration.
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The bond ETF includes a 13.5% position in Chinese debt, followed by 9.9% Brazil, 9.0% Russia, 8.9% Turkey and 8.0% Argentina. Top sector weights include financial 39.7%, energy 17.4%, basic materials 8.7%, industrial 6.3% and government 6.2%.
The credit quality includes investment-grade BBB 0.4%, along with speculative-grade BB 60.7%, B 30.8%, CCC 4.7% and CC 2.3%.
For more information on the fixed-income market, visit our bond ETFs category.