Fixed income investors continue focusing on U.S. interest rates and what the Federal Reserve’s next move might be. While the emphasis on domestic bonds is valid, market participants should be careful to not ignore emerging markets bond opportunities.
Those include debt denominated in local currencies issued by developing countries — an asset class accessible via ETFs like the WisdomTree Emerging Markets Local Debt Fund (ELD). The fund turns 14 years old in August, making it one of the oldest emerging markets bond ETFs and one of the oldest actively managed ETFs of any stripe.
Confirming that the current global interest rate environment could be conducive to investing in emerging markets debt, ELD is higher by 5.1% over the past year, beating the Bloomberg U.S. Aggregate Bond Index by better than 2-to-1 over that period. Some market observers believe there are tailwinds that could prove durable and foster more outperformance of developing world debt over domestic bonds.
Why ELD Could Be Excellent
In a recent report, Joseph Kalish, chief global macro strategist at Ned Davis Research, noted emerging markets debt could outperform domestic corporates, both investment-grade and junk. Of note to investors considering ELD, he also pointed out that the correlations between emerging markets bonds and commodities are weakening, indicating the former can potentially perform well even if the latter doesn’t.
“Many EM economies are commodity exporters and benefit from higher commodity prices and global demand. In recent years, this factor has become less important, as EM economies diversify,” observed Kalish.
Major Commodities Importers
The bulk of ELD’s constituent countries are commodities exporters, but China and India bonds combine for over 18% of the ETF’s roster. And those countries are major commodities importers. Kalish also pointed out that at the regional level, Latin America bonds are displaying leadership in the EM debt space. That’s potentially beneficial to ELD investors because the ETF features Brazil, Colombia, Mexico, Chile, and Peru among its top 12 country exposures.
Amid fears that the Fed isn’t close to lowering rates, ELD has retreated modestly this year. But strong global growth and a possible positive surprise by the U.S. central bank later this year could be catalysts for the ETF.
“As global growth recovers, default risk should recede. In contrast, default risk could rise in the U.S. as the economy slows,” concluded Kalish. “Recovering global growth and potential Fed rate cuts later this year should help weaken the dollar and make it easier for EM economies to service their debt.”
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