Possibility of Negative Yields Could Spark Interest in Emerging Market Debt

The latest inverted yield curve in the 2-year and 10-year Treasury note has been forthcoming since yields were in freefall following the latest market volatility. Negative yields in safe haven government debt is starting to enter the realm of possibilities in the bond markets and this could spark interest in emerging market (EM) debt.

This movement towards EM bonds is already being seen in Europe. Per a Reuters report, European insurers are already “snapping up more emerging-market debt, spurred on by worries that negative-yielding bonds in Europe might not offer enough returns to meet their future payments.”

“Emerging-market hard-currency bonds offer a valid alternative in terms of risk-reward to euro zone core and periphery bonds,” said the head of the asset-management arm of a leading European insurer who asked to remain anonymous.

“We’ve sold some BBB European credit we’ve held and added instead emerging-market exposure of the same rating.”

As the bond markets become more challenging, it could even spill over to lesser yields in riskier assets like high yield debt. As such, this could spur an uptick in emerging market debt, which can offer investors a higher yield versus domestic U.S. debt.

“Investors are engaging in a hunt for yield, which leads to increased demand for emerging-market debt, which offers attractive yield relative to other asset classes,” said a spokesperson for Allianz Global Investors, which manages just over 200 billion euros of the 571 billion euros in assets held by insurer Allianz Group, its parent company.

Before investors start diving headfirst into EM debt, they do need to understand the risks associated with overseas bonds. A couple of areas are the liquidity and volatility these bonds can be subject to with respect to their markets.

“Insurers will be subject to the same risks as any other investor in emerging-market debt, so volatility and liquidity will be of concern,” said Henry Dean, an associate at Eversheds Sutherland.

An option to consider in the EM high-yield bond market is the VanEck Vectors EM High Yield Bond ETF (NYSEArca: HYEM). HYEM seeks to replicate the ICE BofAML Diversified High Yield US Emerging Markets Corporate Plus Index, which is comprised of U.S. dollar denominated bonds issued by non-sovereign emerging market issuers that have a below investment grade rating and that are issued in the major domestic and Eurobond markets.

“The emerging-market universe has grown substantially over the past decade, and with it the number of countries and issuers in the various regions we need to monitor and see investment opportunities in,” said Iva Alexandrova, portfolio manager at AXA Investment Managers, AXA’s asset management business.

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