Market Overview

Looking For Yield? Try This Bond ETF

Looking For Yield? Try This Bond ETF

Although the Federal Reserve has boosted interest rates twice this year, Treasury yields have not ascended in the expected fashion, prompting income investors to continue considering alternatives to prosaic fixed-income assets.

That income search continues to include emerging markets bonds, an asset classes accessible via an array of exchange-traded funds. With the U.S. dollar ranking as one of this year's worst-performing major currencies, emerging markets debt denominated in local currencies can reward investors while delivering yield.

The VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (NYSE: EMLC) has a 30-day SEC yield of 5.5 percent and is up 10 percent year to date. The $4.2 billion ETF holds over 260 emerging markets bonds denominated in local currencies.

Tame Inflation Bodes Well

Emerging markets inflation can often run hot compared to developed market economies, which can weigh on developing world bonds. However, data suggest that inflation is currently benign in some major emerging markets.

“The higher nominal yields of emerging markets local bonds compensate U.S. dollar-based investors for the risk posed by local inflation, which can be associated with negative currency returns, particularly if inflation goes unchecked,” said VanEck in a recent note. “But controlled inflation and positive real interest rates can generally be supportive for a local currency. In addition, positive real rates provide more room for emerging markets central banks to ease monetary policy if economic growth slows. This conventional policy tool may not be as effective in developed markets currently, given extremely low or even negative rates.”

EMLC has an effective duration of 5.15 years. Duration measures a bond's sensitivity to changes in interest rates. The ETF has a yield to worst of almost 6 percent.

What's Inside EMLC

EMLC, which turned seven years old in July, allocates about 37 percent of its combined weight to local currency bonds issued by Brazil, Mexico, Poland and Indonesia. Of that quartet, Brazil has been paring rates and only Mexico is likely to raise rates in the near term, but Mexico's central bank would do that as a means of damping inflation.

“Inflation has generally remained under control in recent years in the countries represented in the J.P. Morgan GBI-EM Global Core Index,” said VanEck. “Even in countries where inflation has been more of a concern (e.g., Mexico and Argentina), central banks have taken hawkish steps, including raising interest rates, and inflation is expected to slow. As of July 31, 2017, the weighted average real 10-year government yield of countries in the Index was 2.3%.”

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