I recently added this holding to my client accounts as a way of diversifying our portfolio exposure to overseas countries with the expectation of future growth and income. I think the current interest rate environment will remain accommodative in the near future and additional upside in emerging market credit will likely be fueled by the continued demand for high-yield assets with more reasonable valuations than developed nations.
When you take into account that U.S. high-yield corporate bonds as measured by the iShares High Yield Corporate Bond ETF (HYG) is trading near all-time highs, it's reasonable to assume that emerging market bonds of similar yield and credit quality are offering a more attractive value proposition at these current levels. I expect that this divergence will eventually correct and we could see money flow into emerging markets as fixed-income investors seek more diversification overseas this year.
With so much of the exposure in EMB concentrated in sovereign debt, some investors may be looking for an alternative with more traditional corporate holdings. My favorite substitute is the actively managed WisdomTree Emerging Markets Corporate Bond Fund (EMCB), which has a slightly lower effective duration of five years and similar yield of 5.12%. It also has more concentrated holdings in Russia and Brazil than EMB.
No matter how you structure your income portfolio, I think it makes sense to include a position in emerging-market bonds as a way to enhance your yield and seek higher returns. While there is the potential for downside risk if interest rates significantly rise or emerging markets once again experience slowing growth, I think the risk-to-reward proposition is reasonable right here.
As I always do, I will be approaching this sector with a risk management mindset that takes into account the need to preserve capital should the prevailing trend reverse.
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