EM Bonds Offer Income as Fed Pauses Rate Hikes

The average yield of the US Treasury index is 2.8%. By contrast, for emerging market bonds denominated in US dollar the average yield is 5.5%

Jose Garcia Zarate 28 February, 2019 | 2:16PM
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Jose Garcia Zarate: Emerging markets had a tough time in 2018, but investors are now looking at them more favourably. The US Federal Reserve has signalled a slowdown in the pace of rate hikes.

As a result, the US dollar has softened, and emerging market currencies have appreciated. Meanwhile in Europe, weaker economic fundamentals now support the case for a more prolonged period of zero rates by the European Central Bank.

ETF flows in Europe have already shown emerging market bonds at the top of investors’ preferences at the start of 2019. It’s easy to understand why. Concerns about global growth favour bond markets. A weaker dollar makes it easier for emerging markets to face their debt repayments, and these economies offer higher yields than their developed counterparts.

The average yield of a US Treasury index covering all maturity segments is around 2.8% at present. This goes down to 1.1% for Eurozone government bonds. By contrast, for emerging market bonds denominated in US dollar is around 5.5%, and for local-currency bonds it goes up to 6.3%.

Investors are advised not to treat emerging markets as a homogeneous asset class and instead discriminate between countries. On paper, this supports an active approach.  However, this is an asset class fraught with difficulties and a geographical diversified low-cost passive approach can deliver a more stable risk-return profile over the long-term.

There is a growing range of passive funds to access emerging market debt, both in ETF and traditional index fund form. Some have been highly rated by Morningstar Analysts.

iShares JP Morgan $ Emerging Markets Bond ETF and L&G Emerging Markets Government Bond USD Index Fund are two options for investors seeking exposure to emerging market bonds denominated in US dollars.  

Meanwhile, for investors willing to take on local currency risk for the reward of higher yield, iShares Emerging Markets Local Government Bond and SPDR Barclays Emerging Markets Local Bond are two interesting options in an ETF wrapper.

These funds track different benchmarks providing varying levels of country diversification, but all four have fared well in the context of their Morningstar Category, inclusive of active funds. Also, they are competitively priced.   

They all carry a Morningstar Analyst Rating of Silver.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Jose Garcia Zarate

Jose Garcia Zarate  is Associate Director of Passive Strategies Research for Morningstar Europe

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