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November 15, 2019Emerging Markets Debt: Yield and Diversification (4:42)
Fran Rodilosso
Fran Rodilosso
Head of Fixed Income ETF Portfolio Management, CFA
Fran Rodilosso, Head of Fixed Income ETF Portfolio Management, discusses how emerging markets debt can fit within a portfolio in the current environment, as he takes a closer look at the yields and diversification that they may offer and the impact of central bank policies.

Positioning a Portfolio in the Current Environment

FRAN RODILOSSO: Investors are looking for a couple of things in our portfolios today: higher yields and diversification. EM [emerging markets] debt in the current environment, with supportive monetary policy by central banks and global growth still being sustained, offer both of those qualities.

Emerging Markets Debt: Yield and Diversification

EM debt offers relatively high yields and a diversification benefit for portfolios, and what we consider at VanEck to still be a benign fundamental backdrop, we think it's still a good time for EM debt investments. The more stimulative policies pursued by developed market central banks and China are providing support for the global growth picture, albeit with some level of deceleration and certainly some geopolitical headwinds. We still actually have a fairly favorable outlook for growth, and that is the key fundamental for EM debt.

Another important thing, investors are looking for yield and diversification in their portfolios. Certainly, EM asset classes, local currency debt, hard currency debt, offer yield enhancement, but on the diversification front, especially in local currency can be an important consideration. Local currency bonds have extremely low correlations with the Agg. or U.S. Treasuries, lower correlations with U.S. corporates than other types of credit exposure do, largely because of the currency risk. But if you look at the fourth quarter of 2018, EM local currency debt was one of the few risky debt asset classes to actually post positive returns.

Impact of Central Bank Policies

Developed market central bank policies [are] having a couple of impacts. First of all, lower for longer and even lower for even longer, which seems to be the case now, is likely creating a situation where emerging markets currencies have much higher yields associated with them to provide support to those currency valuations. Many of which, by the way, are actually at historical lows on [an] inflation- or trade-weighted basis. So, there is value potentially in EM currencies and the lower for longer stance among the developed market central banks actually could be a positive for EM currencies. Also, by the way, just in terms of a relative yield comparison, developed market central banks have pushed yields back toward zero or in negative territory in Europe and Japan. Emerging markets central banks have maintained more orthodox policies throughout. So not only do they have higher nominal yields, they have higher, actually positive, not just higher, but actually positive real yields. Yields above inflation which we think leaves the emerging markets central banks with more room to ease, so higher carry and potential positive movements in local bond prices should emerging markets central banks ease.

Emerging Markets High Yield Bonds Within a Portfolio

We believe there are opportunities in EM corporate bonds, especially on the high yield side. Emerging markets corporate high yield bonds, when they've been between 100 and 200 basis point pickup above U.S. high yield, which is not easy to find these days, but that has been there recently. That's historically been quite a good time to add EM high yield to a portfolio. EM high yield also has higher overall ratings than the broad high yield market or U.S. high yield or global high yield. So average higher credit quality and similar, to lower, duration versus popular U.S. and, broad, global high yield indexes. And also, the diversification benefit can't be overstated. There are nearly 400 issuers in broad emerging markets corporate high yield indexes, coming from 50 countries, distributed pretty evenly around the globe.

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High yield bonds may be subject to greater risk of loss of income and principal and are likely to be more sensitive to adverse economic changes than higher rated bonds. Investments in emerging markets involve risks related to adverse political and economic developments unique to a country or a region, currency fluctuations or controls, and the possibility of arbitrary action by foreign governments, or political, economic or social instability.

All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future performance.

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