An Emerging Markets Trip For Better Bond Yields

The Federal Reserve is lifting the spirits of fixed-income investors and propelling a record amount of cash into bond exchange traded funds this year, but with collapsing U.S. government yields, bond investors are yearning for more — more yield, that is.

What Happened

With 10-year Treasury yields laboring around 1.69% at Thursday's close, emerging market bonds look highly tempting.

For instance, the iShares J.P. Morgan USD Emerging Markets Bond ETF EMB sports a 30-day SEC yield of 4.38% and has returned a tidy 13.15% this year.

EMB, the world's largest emerging markets bond fund, targets the J.P. Morgan EMBI Global Core Index, a collection of nearly 500 dollar-denominated sovereign bonds issued by developing world governments.

Why It's Important

While EMB has certainly compensated investors for the added risk associated with emerging markets bonds relative to Treasuries, both in terms of capital appreciation and yield, some market observers believe the rally in developing world debt can keep going.

“We see factors further supporting EM debt from here: a likely Federal Reserve rate cut this week and the potential for a stable U.S. dollar; an EM growth rebound; and a temporary U.S.-China trade truce,” BlackRock said in a recent note.

“We favor selected EM debt for its income potential.”

EMB has an effective duration of 7.88 years, putting it in intermediate-term territory. Investors do take on some credit risk with this fund compared to an equivalent developed market fund, as 42% of EMB's holdings are rated BB, B or CCC.

To be fair, the highly speculative CCC category represents just 3.3% of the fund's roster.

“So far this year, both hard currency EM bonds — those mainly denominated in U.S. dollars — and their counterparts denominated in local EM currencies (so-called local currency bonds) have delivered strong returns,” according to BlackRock.

What's Next

While the Fed usually commands the bulk of the world's rate cut-related headlines, plenty of emerging markets central banks are joining the party, and that could be another assist for EMB.

“We also see space for further central bank rate cuts in a number of EM countries, including in Indonesia, India, Brazil and Mexico, not least because EM inflation pressures appear to be skewed to the downside,” said BlackRock.

Mexico, Indonesia and Brazil combine for about 14% of EMB's weight.

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