Inflation can chip away at a fixed-income payout, but bond investors may find solace in emerging market bonds and related exchange traded funds where historical real yields have remained attractive.
“Looking for attractive yields? Look no further than emerging markets local currency bonds. These bonds provide significantly higher yields than those offered by developed markets bonds, both in nominal terms and in real terms, i.e., after adjusting for expected inflation. While higher yields often mean greater credit risk, local inflation levels can be a greater contributor to the nominal yields of emerging markets bonds,” Fran Rodilosso, Vaneck’s Head of Fixed Income ETF Portfolio Management, said in a note.
Controlled inflation and positive real interest rates can be supportive of local currency, helping to assuage fears of negative currency returns. Furthermore, emerging market central banks will have more wiggle room to ease monetary policies in light of weaker growth in an environment of positive real rates.
Rodilosso also argued that real yields can provide an indicator of fundamental value versus looking at nominal yields. Emerging market real yields currently appear high relative to historical levels and the difference between EM and developed market real yields looks attractive as well.
As of the end of July, the weighted average real 10-year government yield of countries in the J.P. Morgan GBI-EM Global Core Index was 2.3%, or 2.3% above expected inflation. In Contrast, the real yield on U.S. government bonds was only 0.15%, and negative in other developed economies.