Dollar-denominated emerging markets are outpacing broader measures of U.S. bonds, including the Bloomberg U.S. Aggregate Bond Index, on a year-to-date basis, but local currency haven’t joined the party as of yet. Some market observers believe that scenario is poised to change.
Should that happen, exchange traded funds such as the VanEck J.P. Morgan EM Local Currency Bond ETF (EMLC). EMLC is beating “the Agg” over the past 90 days and should global economic growth prove steady and inflationary pressures remain benign, local currency debt courtesy of developing world issuers could be embraced by global bond investors.
For its part, the $3.02 billion EMLC, which turns 14 years old in July, has sources of allure. The ETF sports a 30-day SEC yield of 6.27% and its geographic exposures confirm the fund can be a useful diversification tool in portfolios that are heavy on domestic bonds. Additionally, EMLC’s effective duration of 4.93 years implies the fund isn’t overly sensitive to interest rate increases.
Speaking of Interest Rates…
Obviously, the central banks in the countries in which bonds are issued figure prominently in the equation for those assets. However, emerging markets bonds, including those found in EMLC, are often sensitive to changes in U.S. interest rate policy. That is to say if the Federal Reserve lowers rates this year, EMLC could benefit.
“We expect most major central banks, led by the U.S. Federal Reserve, to begin cutting their policy rates later in the year as inflation pressures continue to ease,” noted Kathy Jones of Charles Schwab. “Meanwhile, global economic growth appears likely to improve from its relatively sluggish pace of the past year. EM countries, which are often major exporters that benefit most from an upturn in global economic activity and trade, have tended to benefit from those conditions in the past.”
EMLC offers some other benefits. For example, it allocates less than 10% of its weight to Chinese bonds because the J.P. Morgan GBI-EM Global Core Index – EMLC’s underlying gauge – puts limits on individual geographic exposures.
Second, on the interest rate front, some emerging markets central banks are already lowering rates. That’s the result of those entities being more proactive in warding off inflation than was the Federal Reserve.
“Several EM central banks have already started cutting interest rates, raising the prices of their bonds—which move inversely to yields—due to falling inflation after the supply-side shocks of the past few years. With a yield-to-worst of 6.2%, the index’s average yield has fallen by about 60 basis points (or 0.6%) from its recent peak, but it’s well above the 3.74% yield of the Bloomberg Global Aggregate Bond Index,” concluded Jones.
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