By Michael Vodicka
Emerging markets have experienced staggering growth in the past 10 years. And even though growth rates have recently slowed due to weakness in the global economy, they are still expanding at a much faster pace than developed countries like the United States, the United Kingdom and Japan.
Take Brazil, for example. Even though a recent third-quarter gross domestic product (GDP) growth of 0.6% was below expectations, it is still projecting a 4% growth in 2013. That's well ahead of the United States, which is projected to grow by a paltry 2%, and far better than the 1.4% total global growth projected by the Organization for Economic Co-operation and Development.
Other emerging markets are also expected to see big gains.
South Korea is expected to grow GDP to at least 3% in 2013, while the United Arab Emirates is expected to grow its economy to 4.6% next year. Russia, India and China are projected to reach GDP growth of 3.9%, 6.5% and 8%, respectively.
But even though emerging-market growth isn't exactly a new thing on the Street, the way I like to invest in these countries is. In fact, my favorite investments were only available exclusively to professional and high-net-worth investors just a year ago.
I'm talking about high-yielding emerging-market corporate bonds, which can now be obtained through exchange-traded funds (ETFs).
With high yields of up to 7%, emerging-market corporate bonds are way ahead of U.S. corporate bond yields of about 3.8%, and more than three times the yield of the 10-year Treasury note of 1.7%. These ETFs provide investors with exposure to growing companies in emerging markets that have lower credit ratings and leveraged balance sheets. This means these companies are more susceptible to default on their loans, so their borrowing costs are high (hence their higher yields). But as these companies evolve through the natural stages of growth, their borrowing costs decline, producing big capital gains for early investors.
This translates into two things: a shot at some serious capital gains and huge yields. This is why StreetAuthority Co-Founder Paul Tracy, the face behind High-Yield International, says investors should to look overseas if they want to truly find high yields.
But it's important to note that higher yield also comes with more risk, so the great thing about bond ETFs is that, because they hold a basket of bonds, they provide investors with a hedge against single-asset risk.
Here are my three favorite high-yielding emerging-market ETFs. All three of them were launched this year, making them a bit more attractive in terms of valuation.
1. Market Vectors Emerging Markets High-Yield Bond (NYSEARCA:HYEM)
This ETF corresponds to the price and yield of the BofA Merrill Lynch High-Yield US Emerging Markets Liquid Corporate Plus Index, an index of high-yield corporate bonds from emerging markets. With a healthy 7% yield, this ETF has a higher yield than domestic high-yield corporate bond ETFs such as the iShares iBoxx $ High Yield Corporate Bond (NYSEARCA:HYG) and the SPDR Barclays Capital High-Yield Junk Bond (NYSEARCA:JNK), both yielding about 6.8%. HYEM's yield also beats sovereign emerging-market yields of roughly 4%.
With top 10 holdings that include exposure to companies in the Cayman Islands, Indonesia, Brazil and Mexico, this bond ETF provides diversified exposure to exotic locations that, until June, were unavailable to regular investors. Because it was just launched, daily liquidity of 15,500 shares and assets under management of just $21 million make this a satellite holding in your portfolio. But with an expense ratio of just 0.40%, below the category average of 0.52%, this is the perfect place for fixed-income investors to tap into growth and yield with a little value to boot.
2. iShares Emerging Markets High Yield Bond (BATS:EMHY)
This ETF is a step down in risk from HYEM, mixing 60% sovereign debt with 40% high-yield corporate debt. In spite of less risk, investors are still rewarded with a solid 4.5% yield that handily beats the 10-year Treasury note, as well as investment-grade corporate bonds in the United States, which yield about 3.5%.
This is a new ETF as well, hitting the New York Stock Exchange in April. But in just six months, the average daily trading volume has risen to 27,000, while assets under management have jumped to $180 million. Fees of 0.65% are higher than the category average of 0.52%, but with limited choices in this space, only a few options are less expensive.
3. iShares Emerging Markets Corporate Bond (BATS:CEMB)
CEMB corresponds to the Morningstar Emerging Markets Corporate Bond Index. This index tracks a portfolio of bonds with an average credit quality of "BB" and offers diverse geographic exposure with South Korea, Brazil and India in the top 10 country holdings. After launching in April, this ETF is still growing in popularity, with average daily volume of just 6,000 contracts and total assets under management of $21 million. An expense ratio of 0.60% makes it the most expensive ETF of the three, but as more investors catch on to the potential of emerging-market high-yield corporate bonds, this ratio is bound to fall. This ETF boasts a healthy 3.5% yield.
Risks to Consider: High-yield corporate bonds are companies with lower credit ratings and leveraged balance sheets. This leverage is a great asset in a strong economy, but can create liquidity or even solvency issues when economic growth slows. These ETFs also have relatively low trading volume and assets under management, making it easier for big shareholders to affect the market.
Emerging markets are still in the early stages of a long-term growth cycle. So buying high-yield corporate bonds from emerging markets enables investors to lock in an outsized yield with the opportunity to enjoy big capital gains in the long run. Any of these three high-yield emerging-market bond ETFs are an awesome combination of growth and income that are worthy of a place in your portfolio.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.