The VanEck Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC) is trading slightly lower on a year-to-date basis, but with the Federal Reserve and European Central Bank (ECB) looking poised to hold interest rates steady this year, there could be opportunities for tactical fixed income investors to explore emerging markets debt denominated in local currencies.

EMLC seeks to replicate the price and yield performance of the J.P. Morgan GBI-EM Global Core Index. The index is comprised of bonds issued by emerging market governments and denominated in the local currency of the issuer.

“Emerging markets central banks are increasingly reacting to local conditions, and not just to the actions of the Fed and the ECB,” said VanEck in a recent note. “Most Eastern European countries, for example, have turned more hawkish with Hungary, Romania and Poland expected to hike rates amid higher growth and inflation.”

The $5 billion EMLC holds 284 bonds and has an effective duration of 5.06 years. Hungary, Romania and Poland combine for about 14% of the fund’s geographic exposure.

Other Emerging Markets Benefits

As opposed to emerging markets equities that primarily concentrate on China, EMLC also gives investors exposure to other corners of the bond market for diversification. This can help ease any pain should a stronger dollar continue since EMLC’s holdings are less correlated to the greenback.

“Most Latin American countries are also tightening or have a tightening bias, with the exception of Mexico where growth remains sluggish,” said VanEck. “Asian emerging markets are mixed, with some central banks focused on maintaining stability while others are taking advantage of the more conducive external conditions to accommodate growth.”

Brazil and Mexico, Latin America’s two largest economies, combine for over 19% of EMLC’s weight. The ETF has a 30-day SEC yield of 6.89%. About 56% of EMLC’s holdings are rated BBB and BB. Importantly, emerging markets currencies currently are not highly correlated with each other or the U.S. dollar.

“The average correlation between each currency pair was 0.3,” said VanEck. “In addition, the average correlation with the U.S. Dollar Index was 0.5, demonstrating a relatively weak correlation with other developed markets currencies. We believe that in addition to providing diversification away from developed markets central bank policy, these low correlations suggest there is also substantial diversity within emerging markets for investors seeking to gain differentiated exposures.”

For more trends, visit the Tactical Allocation Channel.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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