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High Yield a More Attractive Option in Emerging Markets?

This article was originally published on ETFTrends.com.

2019 has thus far seen the reemergence of emerging markets, but while investors are sifting through the plethora of opportunities the EM space has to offer, it's wise to not overlook the high yield corner of the bond markets.

Domestically, seeking opportunities within high yield might seem like an arcane idea given the serendipitous bull run came to a crashing halt in the volatility-laden fourth quarter of 2018. The risk-on sentiment that fueled three-fourths of 2018 may have gone asunder as the massive sell-offs took place to end 2018.

However, opportunities abroad in the high yield is an option that could prove more attractive that investment-grade debt.

"Investors that include emerging markets corporate bonds within their fixed income portfolio may gain exposure to favorable long-term growth trends in emerging markets," wrote Fran Rodilosso, Head of Fixed Income ETF Portfolio Management at Van Eck. "They may also potentially earn attractive yields and add diversification to a corporate bond portfolio. From a portfolio construction perspective, we believe that focusing on the high yield segment of this market may be a better option compared to a broad exposure that includes both investment grade and high yield securities."

Growing with the Inflows

To start 2019, investors may have been hesitant by the red prices in emerging markets. However, the U.S.-China trade negotiations could be paving the way for a more positive outlook, which has been reflected in the number of inflows into the EM space.

With respect to value compared to price, many of these ETFs from abroad presented a profitable opportunity that can be realized, especially if China and the U.S. eventually ameliorate their trade differences. It presented an opportunity for the investor who is seeking value in terms of locating discounted assets.

Investors have piled $86 billion thus far into EM stocks and bonds, according to data from the Institute of International Finance. The data also reflects investor behavior with regard to broad-market EM exposure within the ETF space.

Emerging markets combined have netted $12.8 billion when looking at the top ten year-to-date inflows with the  iShares Core MSCI Emerging Markets ETF (IEMG) leading the pack–$4.8 billion in YTD inflows.

IEMG is also up 8.42 percent thus far in 2019, which is a far cry from the 14.93-percent decline it experienced in 2018. The fund gained close to 40 percent in 2017 and 10.29 percent in 2016.

The turnaround comes after EM assets were decimated in 2018 thanks to a mix of trade wars and rising interest rates in the U.S.

“Emerging markets had a rough time last year, and this is quite a turnaround,” said Megan Greene, chief economist at Manulife Asset Management. “This rally could have legs.”

A High-Yield Option

An option to consider in the EM high-yield bond market is the VanEck Vectors EM High Yield Bond ETF (HYEM) . HYEM seeks to replicate the ICE BofAML Diversified High Yield US Emerging Markets Corporate Plus Index, which is comprised of U.S. dollar denominated bonds issued by non-sovereign emerging market issuers that have a below investment grade rating and that are issued in the major domestic and Eurobond markets.

According to Morningstar performance numbers, HYEM has yielded a 4.46 percent return thus far in 2019. The fund gives investors the necessary diversification versus relegating a portfolio's fixed income allocation to domestic investment-grade debt.

"In contrast to investment grade rated bonds, emerging markets high yield corporate bonds are not eligible for inclusion in a broad U.S. high yield index such as the ICE BofAML US High Yield Index, so there is virtually no overlap in terms of issuers or individual bonds," wrote Rodilosso. "From a diversification standpoint, this is reflected in a lower correlation to U.S. investment grade corporate bonds and to core bonds versus broad emerging markets corporate bonds. Further, using emerging markets high yield bonds rather than an all-rating exposure provided a higher yield, with less interest rate risk."

High Yield a More Attractive Option in Emerging Markets 1

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