A rebounding bond market this year gave investors much-needed relief following one of the worst slumps on record. While U.S. government debt rebounding is an encouraging sign that could imply that the Federal Reserve will hold off on raising interest rates for the remainder of 2023, risk-tolerant fixed income investors can find higher yields and better performance in emerging markets.
Enter the VanEck J.P. Morgan EM Local Currency Bond ETF (EMLC). As its name implies, the VanEck exchange traded fund holds bonds issued by developing economies denominated in local currencies. On the bond risk spectrum, EMLC holdings are typically far riskier than U.S. Treasuries.
However, the ETF is compensating investors for that risk. This year, EMLC is beating the Bloomberg U.S. Aggregate Bond Index by a four-to-one margin while sporting a 30-day SEC yield of 6.66%. That’s about 250 basis points ahead of the comparable metric on the “Agg.”
Good Time to Examine EMLC
The $3.49 billion EMLC, which tracks the J.P. Morgan GBI-EM Global Core Index, could be a credible fixed income ETF consideration over the near term for a simple reason: Many emerging markets central banks, including those represented among EMLC’s largest geographic exposures, were more aggressive than the Fed in terms of raising rates to fight off inflation.
In this case, “aggressive” means “earlier” because central banks in developing economies were raising rates in 2021, while the Fed got around to it last year. That gives the former group more latitude to consider lowering rates this year, which would benefit EMLC.
“Rapid rate hikes in developed markets have hit emerging market economies hard in the past. It’s the opposite now: capital inflows and stronger currencies boosting returns in emerging market local currency bonds,” according to BlackRock. “Emerging market central banks were well ahead of developed market peers in hiking – and some hiked more to curb inflation quickly. We see some key central banks closer to gradual rate cuts as inflation falls.”
Brazil, EMLC’s third-largest country exposure at a weight of 8.48%, is a prime example of a developing economy that could be primed for a rate cut or cuts. There, the benchmark SELIC rate is 13.75%, and some market observers believe it’s high time the central bank started easing to foster economic growth.
“We get granular going beyond broad emerging market exposures with country preferences in debt. We like Mexico for its quality tilt and Brazil for its exceptional income,” concluded BlackRock.
Brazil and Mexico, Latin America’s two largest economies, combine for over 14% of EMLC’s roster.
Learn more from VanEck about emerging markets bonds at the VettaFi Fixed Income Symposium on July 24.
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