The Federal Reserve on Wednesday lowered interest rates by 25 basis points, a move that along with another rate cut or two, is seen benefiting emerging markets bonds and exchange traded funds, such as the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB) and the Invesco Emerging Markets Sovereign Debt ETF (PCY).
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.
A stabilizing dollar outlook also diminishes the danger of taking on emerging currency exposure, which has historically acted as a large source of volatility for investors investing in local-currency-denominated emerging market debt. While a Fed rate cut helps, some emerging markets central banks are expected to lower rates, too. Brazil got in the act yesterday, paring the Selic rate by 50 basis points.
“Last month’s easing by South Korea, Indonesia and South Africa is a foretaste of things to come as policy makers step up efforts to bolster growth,” reports Bloomberg, citing Angus Bell of Goldman Sachs Asset Management. “A dovish Federal Reserve and improved local fundamentals will only embolden EM central banks to push rates lower, he added.”
Options To Consider
PCY, the first smart beta fixed income ETF launched in 2007, is based on the DBIQ Emerging Markets USD Liquid Balanced Index, which tracks the potential returns of US dollar-denominated government bonds issued by more than 20 emerging-market countries, weighted equally.
With an effective duration of 9.32 years, PCY holds longer duration bonds (up to 30 years) that should react more sharply to a rate cut than the shorter end of the interest rate spectrum, as of July 22, 2019. This approach offers diversified exposure across emerging markets and can result in excess returns over the market value weighted counterparts.
The world is awash in negative-yielding bonds, boosting the allure of emerging markets debt.
“Investors have been piling into the high-yielding securities as the Fed’s signal to ease policy amid faltering global growth saw the amount of negative-yielding bonds around the world rise to $14.1 trillion,” according to Bloomberg.
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