William Sokol, product manager at VanEck writes that it is time to think about a strategic allocation to emerging markets bonds.
Increasing strategic allocation to emerging markets bonds promises more benefits than just higher risk premiums, he writes. As the asset class continues to grow both in size and diversity, emerging markets bonds can boost income producing potential and provide unique diversification.
“An analysis of the past 10 years shows that emerging markets bonds generally exhibit moderate correlation to other core fixed income asset classes,” Sokol explains, “particularly when compared to US equities.”
While the correlation between US high yield bonds and US equities is 0.73, local currency emerging market bonds correlate only 0.62. Even US dollar-denominated emerging market bonds exhibit only a correlation of 0.58 to US equities. The correlation is slightly higher for emerging markets high yield bonds at 0.67. “The generally lower correlation of emerging markets bonds to US equities can indicate a higher potential for diversification within an investor’s credit portfolio."
Besides the lower correlation and high yields, emerging markets bonds may boost the income producing potential of a portfolio. This is shown by the analysis of the weighted average yield to worst (YTW), the lowest potential yield that can be received on a bond without the issuer actually defaulting. Emerging markets corporate high yield bonds achieved the highest YTW of all fixed-income classes with 6.95 pe rcent. To compare: The YTW of US high yield bonds was 6.12 per cent. With an YTW of 6.65 per cent, emerging markets local sovereign bonds came in second.”