Many emerging market assets languished last year. Amid the strong dollar and rising interest rates in some developing economies, local currency bonds were part of this worrying trend.
However, with tighter emerging market rates now largely priced into bond prices, exchange-traded funds like the VanEck JP Morgan EM Local Currency Bond ETF (NYSEArca: EMLC) could be on the verge of emerging from the recent slump this year.
“Despite the recent turmoil in local emerging market bonds, they could be an attractive option based on valuations. At the end of 2021, Morningstar’s Emerging Markets Local Currency Bond category had a median SEC yield of 5.0%, which exceeded the median SEC yield of the high yield bond fund by 4.0%” , says Morningstar analyst Mike Mulach.
$3.5 billion EMLC sports 30-day SEC yield of 5.67%. Additionally, EMLC is showing signs of strength in early 2022. This month, the VanEck ETF is up 0.70%, while the dollar-denominated JP Morgan EMBI Global Core Index is down. of 3.18%.
The fact that some emerging market central banks have already raised borrowing costs could be another catalyst for EMLC in 2022. As investors worry about the impact of Fed rate hikes on domestic bond funds , these worries are alleviated by a strategy like EMLC, and investors can gain the benefit of a richer return.
“In addition to the attractive yield, many emerging market central banks have proactively raised real rates (inflation-adjusted interest rates) at a much faster pace compared to their developed market counterparts, as many many emerging market central banks have been less willing to test whether current inflation will prove transitory,” adds Mulach.
Since emerging market central banks, including those of several countries represented in the EMLC range, were quick to raise rates in an effort to fight inflation, the chasm between real emerging market rates and developed is as high as it has been in more than a decade.
“As a result, the difference between real emerging market rates and real developed market rates is at its highest level in 15 years. This, combined with favorable oil momentum, a continued recovery in growth and a spike in inflation, could lead to a rebound in local emerging market debt,” observes Mulach.
EMLC holds 346 bonds, nearly a third of which are rated AAA, AA or A. The average maturity is 7.22 years with an effective duration of 5.03 years.
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Opinions and predictions expressed herein are solely those of Tom Lydon and may not materialize. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.