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Emerging Market Bond ETFs Are Worth a Second Look

This article was originally published on ETFTrends.com.

After the recent sell-off in developing market assets, emerging market bonds and related ETFs look more attractive for income-minded investors.

Spreads and yields of certain emerging markets debt sectors are now higher than or are in-line with historical averages, according to Fran Rodilosso, Head of Fixed Income ETF Portfolio Management at VanEck. Local currency bond yields are now back above 3- and 5-year averages and are at their 10-year average, which includes both the financial crisis and taper tantrum over the period.

"One area we think is worth attention from a valuation perspective are bonds denominated in local currencies. Real interest rates, which are adjusted for expected inflation, are substantial due to the high nominal yields and inflation levels that remain controlled, in general. In comparison, developed markets real interest rates remain negative or near zero. Further, many currencies are near their lowest level versus the U.S. dollar in over a decade," Rodilosso said.

Those who are wary of trying to catch a falling knife should keep in mind that emerging market debt should not be the main focus of a fixed-income portfolio. Rodilosso argued that investors should look to emerging market bonds as a way to help diversify their fixed-income exposure.

"Allocations should be sized to where an investor is comfortable, and managed so that a portfolio does not become overallocated to any single asset class. The typical advantages of emerging markets debt are its historically lower correlation to other asset classes, higher yield potential, and diversification opportunities. However, the higher volatility is a primary risk," Rodilosso said.

Looking ahead, emerging market fundamentals remain robust. Economic growth in the developing economies continue to be higher than developed markets, and the growth differential is expected to widen. Additionally, EM total debt as a percentage of GDP is much lower compared to the heavily indebted developed markets, and external debt to GDP is now lower than two decades ago.

"We believe the recent selloff may present opportunities for investors who can withstand the volatility in return for the portfolio diversification and yield potential the asset class provides," Rodilosso added.

Bond ETF investors interested in gaining exposure to emerging market local currency bonds have a number of options to choose from. For instance, bond investors may look to something like VanEck Vectors Emerging Markets Local Currency Bond ETF (EMLC) and VanEck Vectors Emerging Markets Aggregate Bond ETF (EMAG) to diversify their fixed-income portfolio with overseas opportunities and potentially higher yield generation.

EMLC is comprised of bonds issued by emerging market governments and denominated in the local currency of the issuer. EMAG holds a basket of sovereign bonds and corporate bonds denominated in local emerging market currencies, along with those denominated in U.S. dollars and euros, and the portfolio includes both investment-grade and below investment-grade debt.

For more information on the fixed-income markets, visit our bond ETFs category.