A Surprisingly Sturdy Corner of the Bond Market | ETF Trends

Over the past several years, emerging market debt denominated in local currencies has been a resilient corner of the bond market.

Over that span, the VanEck J.P. Morgan EM Local Currency Bond ETF (EMLC) performed in line with the Bloomberg US Aggregate Bond Index. And during that time, it sharply outperformed the dollar-denominated J.P. Morgan EMBI Global Core Index and the MSCI Emerging Markets Index. Add to that, EMLC was, over that period, a winner over bonds issued by G7 nations.

Those data points are testaments to the strength of the $3 billion EMLC. But the ETF, which follows the J.P. Morgan GBI-EM Global Core Index, has the potential to continue surprising – for the better – fixed income investors.

EMLC Could Be Strong Long-Term Performer

Some investors might be apt to eschew emerging market bonds, dollar-denominated and local currency, due to perceived risks. There are risks associated with developing world debt. But there’s usually adequate compensation, as highlighted by EMLC’s 30-day SEC yield of 6.19%.

Then there’s long-term performance potential, which is crucial with bonds. That’s because individual bonds and funds such as EMLC are designed to be long-term investments.

“Hard currency EM debt has outperformed both DM government bonds and EM local currency bonds by a much greater degree over the past two decades. [We] believe that the same outperformance drivers have now begun to benefit local currency debt,” noted William Sokol, director of product management at VanEck.

Sokol added that in 2022, one of the worst years on record for global bonds, emerging market debt denominated in local currencies beat developed market equivalents. Fundamentals explain why EMLC has been a winner, and why that that status could extend going forward.

“Low debt and deficits have allowed emerging markets monetary authorities to conduct inflation-focused monetary policy. [That is at the same time that] high debt and deficits in developed markets have diluted central bank independence and their focus on inflation,” observed Sokol.

If low debt and deficits are prioritized by sovereign bondholders, and those factors should be, a case can be made that debt issued by the countries represented in EMLC could be less risky than developed market equivalents.

“Global bond markets are now beginning to recognize the risks embedded in DM government debt and reward the responsible fiscal and monetary policies that have been pursued by many emerging markets over the past several decades,” concluded Sokol.

Roughly a third of the bonds held by EMLC are rated AAA, AA, or A. That implies low credit risk with the ETF.

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