Fixed-income investors who are looking to adapt to changing market conditions may consider factor ETF investing in bond markets and how an allocation to emerging markets can potentially boost yield and increase diversification, without a meaningful increase in duration.
On the recent webcast (available on demand for CE credit), Beyond Factor Fundamentals – Are You Factoring in EM Debt?, David M. Lebovitz, Global Market Strategist for J.P. Morgan Asset Management, highlighted the promising global growth outlook, with the global Purchasing Managers’ Index for manufacturing hovering around 53.4 at the end of last month – readings above 50 indicate an expansion.
Due to the positive growth, strengthening economy, rising inflationary outlook and low unemployment rates, the Federal Reserve should continue to hike interest rates gradually, which could mean pain for high quality bonds, Lebovitz warned. Fixed-income investors who are tracking traditional benchmarks like the Bloomberg Barclays U.S. Aggregate Bond index are now exposed to greater risks with less payouts. Specifically, the Agg showed a 3.12% yield and a 6.1 year duration as the end of last month, but it averaged a 5.20% yield and a 4.8 year duration, which goes to show the greater rate risk and lower yield for the higher risk that investors are now exposed to.
Nevertheless, the U.S. bond market is not the only area that fixed-income investors need to rely on. The U.S. use to make up 61.3% of the global bond market back in 1989, but it is now 36.7% of the total market. On the other hand, developed ex-U.S. makes up 42.7% and emerging market bonds account for 20.6% of the total bond market, but many investor portfolios fall short of this global breakdown.
Moreover, by excluding foreign exposure and focusing solely on U.S. bonds, fixed-income investors may be missing out on attractive yield opportunities. As of the end of March, U.S. aggregate bonds showed a 3.12% yield, but areas like emerging market dollar-denominated debt showed a 5.76% yield, emerging market local currency debt showed a 6.01% yield and emerging corporate bond yields had a 5.05% yield.
Eric Isenberg, Head of Fixed Income Portfolio Management at J.P. Morgan Asset Management, pointed out that the emerging bond category has become more mature and attracted greater investment interest after expanding to $79 billion from $12 billion over the past decade. Investors are also beginning to tap into this emerging bond market through passive products as index-based fund investments gain in popularity.