EM Bond ETFs: Desirable Yield Destinations

July 19, 2016 9:31 am
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Fixed income exchange-traded funds are enjoying plenty of enthusiasm for investors this year. Flows data confirm as much, but advisors and investors keep pumping cash into U.S. Treasury ETFs. That does not change the fact short and middle duration Treasury ETFs are more defensive than legitimate yield plays.

Emerging Markets’ Sovereign Debt

ETFs holding emerging markets’ sovereign debt are where stout yields are found among government bond funds. For example, the $8.1 billion iShares JPMorgan USD Emer Mkt Bnd Fd ETF(NYSE: EMB), now the largest emerging market bond fund in the world, sports a 30-day SEC yield of 4.62 percent. In a world of low yields on U.S. Treasurys and negative yields in other parts of the developed world, EMB tempts.

With good reason. Brexit significantly reduced the chances of the Federal Reserve raising interest rates this month or maybe even this year. The case for the dollar-denominated debt held by EMB and rival ETFs is bolstered in the a “lower for longer” environment because emerging markets bonds denominated in dollars have previously proven sensitive to rising Treasury yields.

Related Link: A Dominant Dividend ETF

It is easy to understand investors' thirst for developing world debt. As Benzinga reported last month, “A whopping $8 trillion in global investment-grade sovereign debt currently sports negative yields, meaning investors that make those bets will lose money. The World Gold Council adds 40 percent of global sovereign debt sports yields below 1 percent.”

“Yet the segment still looks attractive given persistently low developed market bond yields. We believe this relative yield advantage will be a main driver of EM debt returns in the second half. We see hard-currency EM debt providing a more stable income stream than local currency options. EM local debt may offer more upside, however, for those willing to accept currency risk,” said BlackRock in a recent note.

Currencies And Falling Bond Yields

Rebounding emerging markets currencies coupled with falling bond yields in some large developing economies add support for ETFs such as the iShares Emerging Markets Local Currency Bond (NYSE: LEMB).

LEMB has a 30-day SEC yield of 4.23 percent with an effective duration of 4.9 years. The ETF is not exceptionally risky in terms of credit quality, as nearly 52 percent of LEMB's 210 holdings are rated AA or A. Low beta South Korea and volatile Brazil, which has seen sovereign yields decline in recent weeks, combine for over 34 percent of LEMB's geographic weight.

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