Tariffs could be making investors wary of assets in developed countries; namely, Canada, Mexico, and the U.S. of course. This, however, means emerging market (EM) assets like bonds could garner interest.
In the current market landscape, however, investors may have to be selective in their approach. One of the salient points of investing in EM assets is knowing how well the local currency is performing.
“Selective investment in local-currency debt will tend to outperform,” said Marcelo Assalin, head of EM debt at William Blair. “The higher-yielding currencies like Brazil, Mexico, South Africa, Turkey will tend to outperform this year because they are very undervalued fundamentally and they offer much higher carry to investors.”
This doesn't mean that emerging market assets are completely immune to the 24-hour news cycle surrounding tariffs. They are still subject to the ebbs and flows of the broad market response.
“This is a storm that no one will be completely immune to,” said Charles Diebel, head of fixed income at Mediolanum International Funds.
Nonetheless, emerging market bonds do have tailwinds blowing in their favor. Those are yield and also improving credit quality.
Yield & Improved Credit Quality
Yield is often synonymous with emerging market bonds. But credit quality is typically something investors need to sacrifice to attain said yield. However, the underlying fundamentals of emerging market bonds have been improving.
If the Federal Reserve resumes its path to cutting interest rates, that in turn should push the dollar lower. This means local currencies of EM countries that are typically pegged to the greenback should gain, making assets like bonds more attractive. Lower rates elsewhere also means investors can look to EM bonds to extract more yield.
All that said, one fund to consider is the Vanguard Emerging Markets Government Bond ETF (VWOB). The fund tracks the performance of the Bloomberg USD Emerging Markets Government RIC Capped Index. It measures the investment return of U.S.-dollar-denominated bonds issued by governments and government-related issuers in emerging market countries. Over half of VWOB’s portfolio is rated BBB or better. The portfolio skews toward investment-grade debt while adding bonds below investment-grade to extract additional yield.
Knowing which countries' bonds are exhibiting strength will require an investor or advisor to perform their own due diligence. With VWOB, the fund provides broad-based exposure, adding to the diversification it provides as opposed to overconcentrating on one country's bonds.
For more news, information, and analysis, visit the Fixed Income Channel.
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