Emerging markets (EM) have been ground down to a fine powder since the pandemic hit. Now, investors may be ready to sprinkle it into their portfolios given their attractive valuations, especially when it comes to EM debt.
“Emerging-markets local debt has been among the worst-performing fixed-income sectors in recent years, and 2021 was no exception,” said Mike Mulach, a research analyst manager for Morningstar, noting that the JPMorgan GBI-EM Global Diversified Index that tracks EM sovereign debt fell 8.9%, while the JPMorgan EMBI Global Diversified Index that tracks U.S.-dollar-denominated EM sovereign and quasi-sovereign debt lost 1.8%.
A stronger greenback is always a thorn in the side of EM since local currency is a strong indicator of performance. A steady dose of rising rates is expected, which should prop up the dollar even more.
“Rising U.S. rates and inflation concerns as well as slowing Chinese growth and issues in the Chinese property sector contributed to the sell-off in emerging-markets debt,” Mulach explained. “However, the strength of the U.S. dollar relative to many emerging-markets currencies explains why local currency did so much worse.”
Nonetheless, EM debt looks ready to rebound. Mulach noted that valuations are much more attractive given that the close of 2021 saw the EM local currency bond Morningstar Category had a median SEC yield of 5.0%, outdoing the median high-yield bond fund’s SEC yield of 4.0%.
“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,” Mulach said. “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.”
To get this level of exposure to EM debt, fixed income investors can look at the Vanguard Emerging Markets Government Bond Index Fund ETF Shares (VWOB A+). The fund comes with a 0.20% expense ratio.
VWOB seeks to track the performance of a benchmark index that measures the investment return of U.S. dollar-denominated bonds issued by governments and government-related issuers in emerging market countries. The fund employs an indexing investment approach designed to track the performance of the Bloomberg USD Emerging Markets Government RIC Capped Index.
For more news, information, and strategy, visit the Fixed Income Channel.