Plenty of emerging markets assets languished last year. Amid dollar strength and rising interest rates in some developing economies, local currency bonds were part of that ominous trend.
However, with emerging markets rate tightening now largely baked into bond prices, exchange traded funds like the VanEck J.P. Morgan EM Local Currency Bond ETF (NYSEArca: EMLC) could be poised to snap out of recent doldrums this year.
“Despite the recent turmoil in emerging-markets local bonds, they could be an attractive option based on valuations. At the end of 2021, the emerging-markets local-currency bond Morningstar Category had a median SEC yield of 5.0%, which topped the median high-yield bond fund’s SEC yield of 4.0%,” says Morningstar analyst Mike Mulach.
The $3.5 billion EMLC sports a 30-day SEC yield of 5.67%. Plus, EMLC is showing some signs of strength in early 2022. This month, the VanEck ETF is higher by 0.70%, while the dollar-denominated J.P. Morgan EMBI Global Core Index is lower by 3.18%.
The fact that some emerging markets central banks have already boosted borrowing costs could be another catalyst for EMLC in 2022. While investors worry about what Fed rate hikes will do to domestic fixed income funds, those concerns are reduced with a strategy like EMLC, and investors can earn the benefit of a richer yield.
“In addition to the attractive yield, many emerging-markets central banks have proactively raised real rates (interest rates adjusted for inflation) at a much faster pace to their developed-markets peers, as many emerging-markets central banks have been less willing to test if current inflation will prove transitory,” adds Mulach.
Owing to the fact that emerging markets central banks, including those in several countries represented in the EMLC lineup, were quick to elevate rates in an effort to ward off inflation, the chasm between emerging and developed markets real rates is as high as it’s been in over a decade.
“As a result, the difference between emerging-markets real rates and developed-markets real rates is at a 15-year high. This combined with supportive oil dynamics, continued growth recovery, and peaking inflation could lead to a rebound in emerging-markets local debt,” observes Mulach.
EMLC holds 346 bonds, nearly a third of which are rated AAA, AA, or A. The average maturity is 7.22 years with an effective duration of 5.03 years.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.