VWOB: Strong Emerging Market Debt Index ETF, 4.1% Yield
Summary
- Yields are down for most asset classes.
- Emerging market debt is the only exception.
- VWOB is an emerging market debt index ETF and offers investors a good, historically above-average 4.1% yield.
- This idea was discussed in more depth with members of my private investing community, CEF/ETF Income Laboratory. Learn More »
According to the J.P. Morgan, USD-denominated emerging market debt is the only major asset class trading with an above-average yield. The Vanguard Emerging Markets Government Bond ETF (NASDAQ:VWOB) is an index ETF of these same securities, offers investors a good 4.1% yield, and is a strong investment opportunity for income investors wary of current market valuations and conditions. It's not a fantastic choice, but it is one of the few ones offering some value.
Emerging Market Debt - Analysis and Investment Thesis
A quick look at current market conditions before taking a look at VWOB itself.
Valuations and prices have risen for most major asset classes.
Equity valuations have led the pack, with these rising to historical highs. Valuations were higher during the dot-com bubble, but barely and temporarily.
(Source: J.P. Morgan Guide to the Markets)
All industries are overvalued on a historical basis, although some less than others. Financials and healthcare offer some comparative, not absolute, value, and energy could (and has) seen a rebound from improved economic conditions and energy prices.
(Source: J.P. Morgan Guide to the Markets)
All equity market subsections or subdivisions are overvalued. Even value stocks are overvalued on a historical basis.
(Source: J.P. Morgan Guide to the Markets)
Overvaluation could lead to significant shareholder losses if equity prices were to normalize. Markets could also self-correct through sluggish gains for years. Low yields and dividends are, in any case, a reality. Investors need to be prepared for subpar equity returns in the coming years.
Several investment management firms seem to agree. As an example, Vanguard is forecasting annualized U.S. equity returns of about 4.7%, much lower than the double-digit annual returns of this past decade. Expected returns for international equities are quite stronger at 8.0%, but still somewhat lower than past returns.
(Source: Vanguard)
The situation is the same for fixed income securities. Prices are up and yields are down across the board, especially so for Treasuries. This is partly a flight-to-quality phenomenon, Treasuries looked attractive during the worst of the downturn / pandemic, and also partly a result of government intervention, as the Federal Reserve has bought billions in Treasuries these past few months. Other higher-quality fixed income assets, including municipals and investment grade corporate bonds, have seen similar reductions in yields. As with equities, investors could see significant losses if yields were to normalize, and dividends are likely to be lackluster in any case.
As with U.S. equities, Vanguard is forecasting lackluster returns for most fixed-income securities in the coming years:
(Source: Vanguard)
The one exception to the high prices / low yields paradigm is U.S. dollar-denominated emerging market debt. As per J.P. Morgan, said asset class is trading with a slightly above-average yield:
(Source: J.P. Morgan Guide to the Markets)
As can be seen above, emerging market debt yields are about 0.3% higher than average. It is a small difference, but compares favorably to most of other asset classes. Treasuries, for instance, are trading 1.2% lower than average, same figure for U.S. high yield corporate bonds. In percentage terms, the difference is staggering, with yields significantly down across the board for all fixed income asset classes except for emerging market debt:
Notwithstanding the above, the yields themselves are not particularly high. Leveraged loans offer much higher yields, currently 4.9% on average, while U.S. high yield corporate bonds and local currency emerging market debt offer marginally higher yields as well. For the latter, the differences are quite small.
From the above, I think that the investment thesis for these securities is quite clear. Emerging market debt offers investors strong yields and is one of the few asset classes that isn't overvalued on a historical basis. If prices, valuations, and yields were to normalize, investors should expect to see sizable losses in all other asset classes, except emerging market debt.
As such, I think investors should consider including emerging market debt funds in their portfolios. There are many choices in this market niche, but I think VWOB is a particularly good, simple choice. Let's have a look.
Fund Basics
- Sponsor: Vanguard
- Underlying Index: Bloomberg Barclays USD Emerging Markets Government RIC Capped Index
- Expense Ratio: 0.25%
- Dividend Yield: 4.1%
- Total Returns (Inception): 4.2%
Fund Overview
VWOB is an emerging market debt index ETF. The fund tracks the Bloomberg Barclays USD Emerging Markets Government RIC Capped Index, an index of these same securities.
The fund, as its underlying index, invests in all U.S. dollar-denominated bonds issued by emerging market governments, as well as government-owned corporations. Securities must meet a basic set of liquidity, trading, size, and maturity criteria. It is a market-capitalization weighted fund, but weights are capped to ensure diversification. In my opinion, the fund's methodology and holdings are sound, with VWOB faithfully tracking the emerging market debt asset class, with all the benefits that entails.
The resultant fund is quite diversified, with 731 holdings and investments in dozens of countries. No specific bond accounts for over 1% of the value of the fund, and no specific country accounts for more than 10% of the same.
(Source: VWOB Corporate Website)
(Source: ETF.com)
Credit quality is quite low, which is to be expected from a fund focusing on emerging market debt:
(Source: VWOB Corporate Website)
Investors should expect VWOB to perform similarly to other high yield bond funds. Expect significant losses during downturns, higher than that of most bonds, lower than those of equities, and roughly comparable to those of a U.S. high yield corporate bond fund. This was the case during the previous downturn in early 2020:
Yields themselves are also reasonably good. Yields are higher than those of investment grade corporate bonds, bonds in general, but lower than those of high yield bonds.
On the other hand, the figures above are slightly deceptive. As mentioned previously, yields are down for most bonds, but ETFs generally take some time to adjust their dividends. According to data from BlackRock, their flagship corporate bond ETF, the iShares iBoxx $ High Yield Corporate Bond ETF (HYG), only generates 3.7% in income versus 4.1% for VWOB. Expect HYG to cut its dividends until yields are roughly equal to 3.7%. Dividends have already been cut thrice in the year, so a lower dividend yield is all but guaranteed.
So, by investing in VWOB you will almost certainly receive higher dividends when compared to other fixed income funds, and could see some capital appreciation if prices normalize. I think this is a good deal, although nothing too fantastic.
Finally, I would like to add that there are a few other ETFs targeting this same market niche, but not many. The JPMorgan USD Emerging Markets Sovereign Bond ETF (JPMB) is quite similar to VWOB, but with a marginally higher 4.5% dividend yield, and a higher 0.39% expense ratio. AUMs are quite low as well at $83 million. Performance has been effectively identical to VWOB since inception.
JPMB is also a good choice in this market niche, but I slightly prefer VWOB due to its lower expense ratio and higher AUM. The differences are however small.
Conclusion
VWOB is an emerging market debt index ETF. These securities are the only major asset class offering historically above-average yields, and should outperform when valuations, prices, and yields normalize. VWOB is a buy, especially so for income investors concerned about frothy market conditions.
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This article was written by
Juan de la Hoz has worked as a fixed income trader, financial analyst, operations analyst, and as an economics professor. He has experience analyzing, trading, and negotiating fixed-income securities, including bonds, money markets, and interbank trade financing, across markets and currencies. He focuses on dividend, bond, and income funds, with a strong focus on ETFs.
Juan is a contributor to the investing group CEF/ETF Income Laboratory which is led by Stanford Chemist. Features of the service include: managed income portfolios (targeting safe and reliable ~8% yields) making use of high-yield opportunities in the CEF and ETF fund space. These are geared toward both active and passive investors of all experience levels. The vast majority of CEF/ETF Income Laboratory holdings are also monthly-payers, for faster compounding and steady income streams. Other features include 24/7 chat, and trade alerts. Learn More.
Analyst’s Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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