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  • Emerging Markets Bonds

    EM Local Currency Bonds as a Portfolio Stabilizer

    Fran Rodilosso, Head of Fixed Income ETF Portfolio Management, CFA
    August 23, 2019
     

    The reversal in developed markets interest rates over the past year provides a useful case study of how changing market expectations around developed markets rates impacts emerging markets bonds. As shown in the chart below, expectations for a rate hike at the recent July 31, 2019 U.S. Federal Reserve (Fed) meeting began to collapse in November 2018 amid concerns of a growth slowdown. Equities and high yield bonds suffered as a result, but emerging markets local currency bonds were surprisingly resilient during this market volatility. 

    Emerging Markets Local Currency Bonds Outperformed Amid Changing Rate Expectations

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    Source: Morningstar and Bloomberg as of 7/31/2019. Emerging Markets Local Currency Bonds is represented by the J.P. Morgan GBI-EM Global Core Index. U.S. Equities is represented by the S&P 500. U.S. High Yield Bonds is represented by the ICE BofAML U.S. High Yield Bond Index. Emerging Markets Equities is represented by the MSCI Emerging Markets Index. Past performance is no guarantee of future results. For illustrative purposes only.

     

    Although emerging markets local currency valuations remain far below the levels of early 2018 and are very beaten down relative to historical levels, the change in rate expectations has provided support to local currencies, while the attractive yields earned on the asset class have provided investors with a fairly steady source of return. On the other hand, U.S. equities, high yield bonds and emerging markets equities experienced larger drawdowns and elevated volatility over the period, resulting in both lower risk-adjusted and absolute returns.

    The primary risk to emerging markets local currency bonds is a slowdown in global growth, and the unexpected increase in trade tensions between the U.S. and China should be closely monitored. Growth concerns have in fact been one factor in negative returns for emerging markets local debt in August.  But a larger factor has been a rapid decline in the Argentine peso in reaction to primary election results. One reason an index approach to emerging markets local bonds has worked well is that idiosyncratic risk can lead to high volatility in various emerging markets local markets, particularly the highest yielding ones. A well-diversified portfolio can take advantage of the overall high yields in the asset class while avoiding highly concentrated exposures to a single currency.

    However, we believe several tailwinds will provide support to the asset class: prolonged low rates across developed markets, emerging markets monetary policy that has turned dovish and historically low valuations of emerging market currencies. With their attractive yield potential, diversification benefits and recent resiliency amid these changing market conditions, we believe emerging markets local currency bonds may be an attractive addition to fixed income portfolios.

     

    DISCLOSURE

    Please note that Van Eck Associates Corporation serves as investment advisor to investment products that invest in the asset class(es) included herein.

    This content is published in the United States for residents of specified countries. Investors are subject to securities and tax regulations within their applicable jurisdictions that are not addressed in this content. Nothing in this content should be considered a solicitation to buy or an offer to sell shares of any investment in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction, nor is it intended as investment, tax, financial, or legal advice. Investors should seek such professional advice for their particular situation and jurisdiction.

    The information herein represents the opinion of the author(s), but not necessarily those of VanEck, and these opinions may change at any time and from time to time. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. Historical performance is not indicative of future results. Current data may differ from data quoted. Any graphs shown herein are for illustrative purposes only.

    Index returns are not Fund returns and do not reflect any management fees or brokerage expenses. Certain indices may take into account withholding taxes. Investors can not invest directly in the Index. Returns for actual Fund investors may differ from what is shown because of differences in timing, the amount invested and fees and expenses. Index returns assume that dividends have been reinvested.

    J.P. Morgan GBI-EM Global Core Index tracks local currency denominated EM government debt. The index weighting methodology limits the weight of countries with larger debt stocks, with a maximum of 10% and a minimum of 3%. S&P 500 measures the stock performance of 500 large companies listed on stock exchanges in the United States. ICE BofAML U.S. High Yield Bond Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market. MSCI Emerging Markets Index tracks large and mid cap stocks across emerging markets countries.

    All investing is subject to risk, including the possible loss of the money you invest. Bonds and bond funds will decrease in value as interest rates rise. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future results.