Strong Relative Performance
High yield emerging markets corporate bonds have had a strong start to the year, outperforming emerging markets equities with a 7.75% year-to-date return at the end of May.
Longer term, the asset class has returned on average 7.40% per annum over the past 10 years (for the period ending 5/31/2016), outperforming both U.S. high yield corporates and emerging markets equities. Given this attractive long-term performance, it's worth taking a closer look at the potential value that this asset class can provide.
Performance Comparison: Average Annual Total Returns as of 5/31/2016
|Asset Class||YTD %||1 YR %||3 YR %||5 YR %||10 YR %|
|HY Emerging Markets Corporate Bonds||7.75||2.33||3.07||4.72||7.40|
|HY U.S. Corporate Bonds||8.15||-0.92||2.89||5.26||7.28|
|Emerging Markets Equity||2.32||-17.63||-4.95||-4.83||3.11|
Source: Morningstar and Bloomberg; see definitions below. Past performance is not a guarantee of future results. Index returns are not Fund returns and do not reflect any management fees or brokerage expenses. HYEM performance current to the most recent month end is available here.
The high yield emerging markets bond sector, as measured by the BofA Merrill Lynch Diversified High Yield US Emerging Markets Corporate Plus Index, has grown tremendously in the past 10 years, from a market value of $33 billion in 2006 to approximately $346 billion today. Although emerging markets corporate issuers may issue bonds denominated in local currencies, the vast majority of high yield emerging markets bonds are U.S. dollar denominated (and are the focus here), which significantly reduces the currency risk to U.S. investors.
At the end of May, the sector was yielding 8.42%. That was approximately 1% more than U.S. high yield (7.43%), while also having a lower duration (3.80 versus 4.33), a higher average credit rating, and a historically lower average default rate.
Why Higher Yields?
Emerging markets corporate issuers have traditionally had to pay more for financing versus their similarly rated U.S. market counterparts due to the additional risks generally associated with emerging markets investing. For example, the average spread of BB-rated emerging markets bonds was 58 basis points higher than those of U.S. bonds falling into the same ratings bucket, as of May 31, 2016. For B-rated bonds, that spread differential was nearly 200 basis points.
High Yield Emerging Markets Bonds Provide Higher Spreads Per Rating Versus U.S. High Yield (as of 5/31/16)
Source: BofA Merrill Lynch
Certain emerging markets corporate issuers may have credit ratings that reflect higher risk profiles than their corporate fundamentals alone would suggest, and pay higher yields than similar issuers based in developed markets. Why? Because a local sovereign credit rating can be a significant determinant of the credit rating on a corporate issuer's foreign currency bonds. The risk that a national government may impose restrictions limiting an issuer's ability to convert local currency into foreign currency to fulfill its external debt obligations is taken into account by rating agencies. This risk is generally higher for emerging markets countries, and therefore this "rating ceiling" can have a meaningful impact on an emerging markets corporate issuer's credit rating. This can create value for investors, who can potentially earn a higher yield relative to the underlying corporate risk they are taking.
The yield provided by high yield emerging markets bonds reflects both the potential risks and the value that the asset class can provide. High yield emerging markets bonds can provide an income-producing complement to an investment in emerging markets equities, and can also provide issuer and regional diversification alongside a domestic high yield allocation.
High yield emerging markets bonds can be accessed through VanEck Vectors Emerging Markets High Yield Bond ETF (NYSEARCA:HYEM).
Definitions and Index Descriptions:
Duration is a measure of the sensitivity of the price of a fixed-income investment to a change in interest rates.
High Yield Emerging Markets Bonds is represented by the BofA Merrill Lynch Diversified High Yield US Emerging Markets Corporate Plus Index. HY US Corporate Bonds is represented by the BofA Merrill Lynch US High Yield Index. Emerging Markets Equity is represented by the MSCI Emerging Markets NR Index.
Ratings are determined based on index provider methodology.
An index's performance is not illustrative of a fund's performance. Indices are not securities in which investments can be made.
BofA Merrill Lynch US High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market. Qualifying securities must have risk exposure to countries that are members of the FX-G10, Western Europe or territories of the US and Western Europe.
BofA Merrill Lynch Diversified High Yield US Emerging Markets Corporate Plus Index tracks the performance of US dollar denominated below investment grade emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets. In order to qualify for inclusion an issuer must have risk exposure to countries other than members of the FX G10, all Western European countries, and territories of the US and Western European countries.
MSCI Emerging Markets NR Index is designed to measure equity market performance in the global emerging markets.
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An investment in VanEck Vectors Emerging Markets High Yield Bond ETF may be subject to risk which include, among others, credit risk, call risk, interest rate risk, and quasi-sovereign defaults, all of which may adversely affect the Fund. High yield bonds may be subject to greater risk of loss of income and principal and are likely to be more sensitive to adverse economic changes than higher rated securities. International investing involves additional risks which include greater market volatility, the availability of less reliable financial information, higher transactional and custody costs, taxation by foreign governments, decreased market liquidity and political instability. Changes in currency exchange rates may negatively impact the Fund's return. Investments in emerging markets securities are subject to elevated risks which include, among others, expropriation, confiscatory taxation, issues with repatriation of investment income, limitations of foreign ownership, political instability, armed conflict and social instability. The Fund's assets may be concentrated in a particular sector and may be subject to more risk than investments in a diverse group of sectors.
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