Emerging Market Corporate Bonds: The Next Frontier
Emerging market corporate debt is a small but fast-growing asset class that offers investors high yield and a way to participate in the rapid growth of the emerging market economies. But be wary: emerging market corporate bonds also have a high degree of risk.
In the past, the term “emerging market bonds” referred almost exclusively to plain-vanilla government debt. Today, however, the rapid growth of the emerging economies is leading to the development of a broader range of options within the asset class, including inflation-linked bonds, debt denominated in local currencies, “dim sum” bonds, and corporate bonds.
Emerging market corporate bonds, in particular, have become a focus of attention due to their attractive yield premiums over domestic corporates and their ability to augment diversification within a traditional fixed income portfolio.
Learn more: Investing in emerging market bonds
Emerging market corporate bonds offer investors a way to capitalize on the growing creditworthiness of companies in the world's developing countries. Improving corporate governance, rising profit margins, and lower levels of corporate debt are all factors that provide a favorable long-term underpinning for this asset class.
The market’s rapid growth has led to improved liquidity; or in other words, the ability of investors to buy and sell securities without having a large impact on prices. In the fourth quarter of 2012, the total value of the asset class eclipsed $1 trillion - about equal to the U.S. high yield market. Also, while the emerging market corporate bond arena traditionally has been dominated by Latin American issuers, the rising amount of new issuance from Asia, Europe, and Africa, as well as from a wider variety of issuers on the sector level, is providing investors with an expanding range of options.
The Risks of Emerging Market Corporate Bonds
The emerging markets have come a long way since the 1990s, when they were known for boom-bust cycles that led to frequent crises and extraordinary market volatility. Today, emerging market countries feature lower debt and much better fiscal management than was the case just 20 years ago. Having said that, it’s important to remember that the emerging markets are vulnerable to underperformance during the times in which investors grow nervous and begin looking for ways to trim the risk in their portfolios. Corporate bonds, which are seen as being higher-risk than government issues, are particularly vulnerable to periods of elevated investor risk aversion. This is especially true when it comes to high yield corporate bonds. As a result, investors need to think carefully about the risk-reward tradeoff when deciding whether to take advantage of the higher yields in emerging market corporates.
How to Invest in Emerging Market Corporate Bonds
Many broad-based emerging market mutual funds have diversified their portfolios into corporate bonds rather than remaining invested entirely in government issues. Third-party sources such as Yahoo! Finance, or the fund companies themselves, provide data on how a fund’s portfolio is allocated.
Investors also have several options to invest in this area via exchange-traded funds (ETFs):
- WisdomTree Emerging Markets Corporate Bond Fund (EMCB)
- iShares Emerging Markets Corporate Bond Fund (CEMB)
- SPDR BofA Merrill Lynch Emerging Markets Corporate Bond ETF (EMCD)
- Market Vectors Emerging Markets High-Yield ETF (HYEM)
- iShares Emerging Markets High Yield Bond Fund (EMHY)
The growth of this relatively new asset class will undoubtedly draw in investors who are looking for higher yields and a way to augment portfolio diversification. But remember: the risks are higher here than in just about any other segment of the global bond market.
Disclaimer: The information on this site is provided for discussion purposes only, and should not be construed as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.