Corporate bonds

These corporate bonds offer surprising benefits

At a time of rising interest rates in the United States and some developing economies, bond investors may not be thinking about emerging market debt.

Add to that that many are unlikely to consider borrowing from high-yielding companies thanks to issuers in developing markets, but there is a case to be made for this asset class and exchange-traded funds such as the VanEck Vectors Emerging Markets High Yield Bond ETF (HYEM).

HYEM, which tracks the ICE BofA Diversified High Yield US Emerging Markets Corporate Plus Index, beats the largest US-focused junk bond ETF by 160 basis points in the past six months. Although this is a relatively short time frame, it does not diminish the benefits that could be offered by HYEM, many of which are overlooked by bond investors. These benefits include reduced currency risk, which is something to consider in times when the dollar is strong.

At the end of July, “Emerging markets USD high yield corporate bonds, as represented by the ICE BofA Diversified High Yield US Emerging Markets Corporate Plus Index (the “Index”), produced a return of 11.3%, the highest among major fixed income asset classes and 3.5% more than US high yield bonds,” noted William Sokol, Senior Product Manager VanEck.

As noted by Sokol, if one excludes the controversial and volatile real estate debt of Chinese companies, the case for emerging market high yield bonds is even more attractive, especially when attributed persistent yield advantages by compared to equivalent national obligations. Moreover, the issue does not dilute the market.

“New emerging market corporate debt issuance was extremely weak in the first eight months of the year, providing further technical support. Net issuance (excluding coupons) by emerging market companies year-to-date is negative at -$63 billion, more than offsetting outflows,” Sokol added.

Default rates, which always worry investors regardless of geography, are higher this year by historical standards, but that’s largely driven by Chinese property issuers and Russia. The good news for HYEM investors is that these flaws are in the rearview mirror.

In addition to the HYEM case, much of its geographic exposure is positively correlated to the stronger dollar, due to the heavily export-oriented nature of many of the economies represented in the ETF.

“The index has nearly 40% of its holdings allocated to exporting economies6, such as China, Mexico, Brazil, South Africa and Indonesia. Chinese exports showed robust growth in July and jumped 18% in dollar terms from a year ago,” Sokol concluded.

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Opinions and predictions expressed herein are solely those of Tom Lydon and may not materialize. 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.