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Investors that include emerging markets corporate bonds within their fixed income portfolio may gain exposure to favorable long-term growth trends in emerging markets. They may also potentially earn attractive yields and add diversification to a corporate bond portfolio. From a portfolio construction perspective, we believe that focusing on the high yield segment of this market may be a better option compared to a broad exposure that includes both investment grade and high yield securities.
Emerging markets bonds that are rated investment grade, issued in U.S. dollars and in the U.S. market, are generally eligible for inclusion in broad U.S. corporate bond benchmarks, assuming that they also meet other index criteria such as minimum amount outstanding. The result is that about 35% of the emerging markets corporate bond benchmark is also included in the U.S. corporate bond benchmark.1 Investors may have more exposure to certain emerging markets issuers than intended, and may not be fully taking advantage of the benefits that emerging markets high yield bonds may offer.
In contrast to investment grade rated bonds, emerging markets high yield corporate bonds are not eligible for inclusion in a broad U.S. high yield index such as the ICE BofAML US High Yield Index, so there is virtually no overlap in terms of issuers or individual bonds.2 From a diversification standpoint, this is reflected in a lower correlation to U.S. investment grade corporate bonds and to core bonds versus broad emerging markets corporate bonds.3 Further, using emerging markets high yield bonds rather than an all-rating exposure provided a higher yield, with less interest rate risk.
Enhance a Corporate Bond Portfolio
Source: ICE Data Services. Data as of 1/31/19.
Index design typically reflects market conventions and investor behavior, but can have unexpected and surprising impacts on portfolio exposures. Because there is virtually no overlap with U.S. high yield corporate benchmarks, and because investors may already have exposure to investment grade emerging markets corporates through a U.S. corporate bond allocation, we believe that emerging markets high yield corporate bonds can allow investors to better calibrate their exposures to achieve desired outcomes.
IMPORTANT DEFINITIONS AND DISCLOSURES
1Source: ICE Data Indices as of 1/31/2019. Represents the portion of the ICE BofAML Emerging Markets Corporate Plus Index that is represented in the ICE BofAML US Corporate Index
2Source: ICE Data Indices as of 1/31/2019. Represents the portion of the ICE BofAML Diversified High Yield US Emerging Markets Corporate Plus Index that is represented in the ICE BofAML US High Yield Index
3Source: Morningstar as of 1/31/2019 based on 5-year monthly return correlation of the ICE BofAML Diversified High Yield US Emerging Markets Corporate Plus Index and ICE BofAML Emerging Markets Corporate Plus Index to the ICE BofAML US Corporate Index and Bloomberg Barclays U.S. Aggregate Bond Index.
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