Last year the JPMorgan Global Emerging Market Bond index had a total return of 9.1 percent.
“We believe U.S. investors should have an allocation to emerging market bonds,” said Pablo Goldberg, a senior fixed-income strategist for BlackRock, which manages more than $24 billion in assets in a variety of emerging market bond funds. “They have a higher yield, they have good fundamentals, commodities prices are firm, and investors can diversify their currency risk.”
There is one good reason not to buy EM bonds, however: They carry a lot of risk.
In the bipolar investment markets post-financial crisis, emerging market assets — both stocks and bonds — have always been among the first assets to suffer when things get volatile. Witness the sharp drop in EM asset values after the so-called Taper Tantrum in 2013, when the Federal Reserve said it would scale back its bond-buying program. The sector experienced a two-year hangover.
With the return of volatility in domestic markets, the question now for yield-seekers in emerging markets is whether this time around things will be different.
George Rusnak thinks so.
“The emerging markets are more robust now,” said Rusnak, co-head of fixed-income strategy for the Wells Fargo Investment Institute. “More countries and companies issue debt in their own currency, and they have better access to markets across the liquidity curve.
“It makes them better able to withstand challenging times,” he added.
These are challenging times. With interest rates in the United States rising, emerging market debt becomes relatively less valuable and prone to flights of capital if a risk off mentality rears its ugly head again. Emerging market currencies have also been falling relative to the U.S. dollar of late. Already, the sector (as represented by the iShares JPMorgan USD Emerging Markets Bond ETF) is down more than 5 percent for the year through May 16. If the 10-year Treasury bond yield continues to rise through the 3 percent level, it will get worse for emerging markets — particularly for local currency denominated funds that suffer from a stronger U.S. dollar.
This time, however, it could be different. For one thing, most analysts and economists expect long-term rates in the United States to trade within a range as inflation remains muted and the domestic economic expansion approaches its 10th year.
“The 3 percent level is still quite low, and we don’t think it will decrease the search for yield,” said BlackRock’s Goldberg. “What could hurt emerging markets, however, is if rates start rising rapidly.”