This Emerging Markets Bond ETF Pairs Yield and Growth

An improving macroeconomic landscape could be providing opportunities in emerging markets (EM) debt. It’s an option worth considering, especially if the fixed income goal is to pair yield with growth.

Rising interest rates and a strengthening U.S. dollar stifled an EM rally following the onset of the COVID-19 pandemic in 2020. Often, strength in EM assets follow the performance of the local currency and a strong dollar against the local currency could translate to weakness.

However, as global central banks look to pivot from tight monetary policy, that could pave the way for upside in EM assets like bonds. Global asset management firm Janus Henderson highlighted this in a market analysis report.

“Despite the headlines, many emerging markets remain relatively robust, with progress on fiscal consolidation and improving debt metrics,” they said, citing strong real GDP growth as factor.

“Also positive for EM countries, they have ample scope for monetary policy easing due to the higher starting point for real rates and improving inflation dynamics,” the report added. “EM inflation is falling, as evidenced by global supply chain normalisation and weakening PPI – most notably in China. EM central banks were early into the rate hiking cycle relative to the rest of the world – inflation is now falling and a number of these central banks are now closer to start cutting rates (eg. Brazil, Mexico), providing a buffer – although this is not universal. The policy response in EM to rising inflation, in our view, solidifies EM policy credibility.”

An EM Opportunity in Government Debt

Fixed income investors ready to dial up the credit risk — but not too high — may want to consider EM government debt. That’s exactly what the Invesco Emerging Markets Sovereign Debt ETF (PCY) addresses.

PCY is based on the DBIQ Emerging Market USD Liquid Balanced Index. The index tracks the potential returns of a theoretical portfolio of liquid emerging markets U.S. dollar-denominated government bonds issued by more than 20 emerging market countries. Countries in the index are selected annually pursuant to a proprietary index methodology.

Currently, about 15% of its holdings reside in Kenya government bonds. Given the country’s growth prospects, it’s an ample opportunity to obtain yield and growth.

“Kenya’s economy is expected to grow at a slightly faster pace this year,” a Reuters report said. “The East African nation’s economy will expand by 5.0% in 2023, the bank said in its latest biannual Kenya Economic Update report, inching up from 4.8% last year.”

As of August 9, the fund’s 30-day SEC yield is 7.72%, and its 12-month distribution rate is 6.36%.

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