As the Federal Reserve continues to pump liquidity into financial markets and interest rates stay low, investors are turning to emerging market fixed-income assets and exchange traded funds for quality, capital growth and, most importantly, yields.
Analysts at Ned Davis Research and TCW argue that emerging market sovereign debt has a lot of potential, writes Trang Ho for Investor Business Daily.
For instance, Neil Leeson, ETF Strategist, points out that if global growth gains momentum, emerging market currencies will strengthen against the dollar, which would boost local currency-denominated emerging market bonds.
Moreover, loose monetary policies will devalue the U.S. dollar.
"Expansionary monetary policy in developed markets tends to boost commodity prices and hence has a positive spillover to emerging market trade balances," TCW said in the article. "There are already incipient signs of stabilization in global manufacturing activity, which historically has triggered outperformance of emerging markets as an asset class, in particular local currency bonds."
The emerging markets are also saddled with lower debt burdens and smaller deficits than many developed economies - large debt would hinder growth as indebted countries pay back loans or cut spending.
"EM local markets offer positive real interest rates reflecting market-driven supply and demand for funding," TCW strategists said. "In contrast, financial repression through aggressive quantitative easing has resulted in negative real rates of return in the developed world."
Currently, emerging market bonds on average provide 4.75% more yield than U.S. Treasuries. Additionally, emerging debt offers diversification qualities beyond the normal fixed-income assets.
"Based on returns and volatility over the last decade, allocating 19% of a global fixed-income portfolio to emerging market local currency bonds would have improved annual average returns by 200 basis points (2%), while reducing portfolio volatility by 100 basis points (1%)," according to TCW.
While some may associate "emerging" with greater risk, most of the underlying bonds in emerging market bond funds are investment-grade quality.
Some emerging market sovereign debt ETFs include:
- PowerShares Emerging Markets Sovereign Debt (NYSEARCA:PCY). The ETF has a 4.03% 30-day SEC yield and a 0.50% expense ratio. PCY holds U.S. dollar-denominated emerging market debt.
- IShares JPMorgan USD Emerging Markets Bond (NYSEARCA:EMB). The ETF has a 3.35% 30-day SEC yield and a 0.60% expense ratio. EMB holds U.S. dollar-denominated emerging market debt.
- Market Vectors EM Local Currency Bond ETF (NYSEARCA:EMLC). The ETF has a 5.12% 30-day SEC yield and a 0.47% expense ratio. EMLC holds emerging market bonds denominated in their local currencies, which are subject to currency risks.
Max Chen contributed to this article.
Full disclosure: Tom Lydon's clients own EMB.
Disclosure: I am long EMB. 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.