Here’s what you should know about adding emerging markets bond exposure to your portfolio
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It may be time to consider adding emerging markets bonds to your fixed-income portfolio. After shying away from high-quality EM bonds last year, Vanguard senior portfolio manager Daniel Shaykevich now sees value as more supply hits the market and spreads widen. He’s largely bought bonds that are issued in major foreign currencies . “It’s a good way to get income, get into a good story at a very strong relative valuation and at the same time participate in the potential performance of fixed-income assets more broadly,” said Shaykevich, co-head of Vanguard’s emerging markets and sovereign debt team. His Vanguard Emerging Markets Bond Fund (VEGBX) is rated five stars by Morningstar. In fact, if you are investing in bonds beyond Treasurys, “you’d be doing yourself a disservice if you did not include emerging market debt in your allocation,” he added. With EM debt, you are getting both duration and spread, Shaykevich explained . Spread is the difference between the yields of two bonds. U.S. investment-grade bonds currently have tight credit spreads and in high yield, it’s rare to have issuances longer than five years, he said. EM governments tend to borrow longer term in U.S. dollars, he added. “So you have a long-duration asset class that also has a lot of spread,” Shaykevich said. Duration is a measurement of a bond’s price sensitivity to changes in interest rates, and longer-dated issues tend to have greater duration. VEGBX has an average duration of 6 1/2 years. BlackRock also likes emerging markets, specifically external currency debt. EM spreads remain near the long term average, while U.S. high-yield credit spreads are well below the long-term average — “a sign of expensive valuations,” said Wei Li, BlackRock Investment Institute’s global chief investment strategist, in a note Monday. “Along with attractive relative value, it includes more countries with higher quality credit ratings than riskier high yield. Often issued in U.S. dollars, hard currency EM debt is also cushioned from EM currency weakness as EM central banks cut rates,” she wrote. Vanguard’s Shaykevich prefers bonds from Latin America because he sees more value there right now. He most recently added debt from Mexico and Brazil to his portfolios, as well as bonds from Saudi Arabia. He suggests working with an advisor if you want to add EM bonds to your portfolio. “It’s just really important to understand the type of risk they’re taking,” he said. For investors who want to get into the space through mutual funds or ETFs, here are a few selections. Be mindful of fund expenses, which can take a bite out of returns if they are too high. EM bonds span the credit spectrum, so you can have highly-rated issues and those in some degrees of distress, Shaykevich said. Credit quality should be a consideration as investors add exposure to the space. “It’s very important that they take diversification seriously and that they consider the relative concentration of the asset class when they are deciding what’s the right amount to allocate to these strategies,” he said.
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