Emerging Markets Debt Holds Big Potential | ETF Trends

Following a dismal run in 2022 at the hands of Federal Reserve tightening, emerging markets debt, including bonds denominated in local currencies, is enjoying a renaissance in 2023.

While that’s true of a variety of corners of the fixed income space, bonds denominated in local currencies issued by developing world governments are strutting their stuff this year. Take the case of the VanEck J.P. Morgan EM Local Currency Bond ETF (EMLC). As of Sept. 1, that exchange traded fund is higher by 7.1% year-to-date, beating the Bloomberg Aggregate US Bond Index by a margin of better than 6-to-1.

EMLC, which tracks the J.P. Morgan GBI-EM Global Core Index, is delivering that impressive performance with the benefit of an appealing 30-day SEC yield of 6.74%, confirming bond investors can have their cake and eat it too in terms of performance and yield with EMLC.

EM Bond Fundamentals Have Solid Fundamentals

Regarding equities, emerging markets excluding China are performing admirably this year. On that note, EMLC’s 2023 performance is all the more impressive when considering the ETF allocates 10.60% of its weight to renminbi-denominated bonds — an asset class encountering headwinds in 2023.

EMLC’s sturdiness speaks to the benefits of geographic diversification and sound fixed income fundamentals in other developing economies. As Jean-Charles Sambor, BNP Paribas head of emerging markets debt, noted, inflation is trending lower in many emerging markets. That’s confirmation that pro-active steps taken by central banks in those nations in 2021 paid off.

Additionally, fiscal accounts and balance of payments in emerging markets are increasing with many developing economies accumulating reserves, observes Sambor. Further cementing a strong fundamental picture for EMLC is the point that deficits are declining in some emerging economies.

It remains to be seen if that’s enough for ratings agencies to upgrade credit grades on EMLC member countries, but that factor is undoubtedly positive. As things stand, about 71% of EMLC holdings are carry investment-grade ratings, including nearly a third with AAA, AA, or A ratings. That’s the result of fiscal stimulus being limited in emerging markets relative to developed economies. Other factors could bode well for EMLC as well.

“On hard currency debt, spreads over US Treasuries are likely to narrow, leaving EM high-yield bonds in particular with scope for outsized returns. Local currency debt is at a turning point as it looks set to reverse last year’s US-dollar-related weakness given the potential for EM central banks to cut policy rates this year and next,” according to BNP Paribas.

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