What do you think of emerging market bonds, if you actually do think about them? Well, in the recent years, emerging market bonds, in other words, fixed income debt, issued by companies from developing countries, gained popularity and found a place in many investor portfolios.
This trend can be easily explained. Emerging market bonds have got the enhanced credit quality and higher yields in comparison with your national corporate bonds. However, as it always happens in the world of investments, larger returns presuppose higher risks. That’s why today we’ll try to compare risks and benefits of emerging market bonds vs. other fixed income asset types.
A bit of history
Back in the1980s, Nicholas Brady, US Treasury Secretary at the time, started a programme to help international economies restructure their debt by issuing bonds. Since that time, many countries have used this opportunity and issued ‘Brady bonds’; it has started the emerging debt market.
Day after day growing economies issued bonds using their national currencies and dollar denominations more frequently. This tendency got the name ‘emerging local market bonds’. As a result, international companies started selling their debt, boosting the corporate credit market.
Evaluate potential risks
Basically, if you’re going to invest in emerging market bonds, you can face the typical debt issues risks, such as fluctuations of issuers’ performance and their capability to pay back their obligations. Nevertheless, you should take into account that these risks may realistically be even higher because the economic situation in developing countries can be rather volatile and unstable.
While assessing the risks, don’t forget about cross-border threats, such as currency exchange fluctuations. If a chosen bond is issued in the local currency, you automatically become dependent on the dollar rate against the given currency. If the local currency feels strong enough, your yield will be higher; and vice versa, if the local currency is weak compared to the dollar, your return will go down.
Track the developing markets
There are several indices that help to track the performance of the developing markets and their bonds, for example, EMBI Global (the J.P. Morgan Emerging Markets Bond Index) and CEMBI (the J.P. Morgan Corporate Emerging Markets Bond Index).
The EMBI Index consolidates the debt of 25 countries, including China, Brazil, South Africa, Russia and Poland. Whereas the CEMBI concentrates on 80 bonds, issued by 50 companies worldwide.
Luckily you won’t have to assess the risks on your own. Specialised rating agencies successfully perform this task, measuring the country’s capability to execute their debt obligations. Moody’s and S&P’s ratings are considered as the most reliable. The higher the rating, the more chances the country will pay its debt.
Besides, there is a special instrument that can protect you from this risk – the credit default swap (CDS). According to the swap contract, you’ll receive the face value of the debt back in exchange for the underlying securities or their cash equivalent, in case a country or a company fails to repay its debt.
Ready to invest?
Despite all the risks and concerns, emerging market bonds can bring you much profit.
Firstly, the bonds make your investment portfolio diverse; and additionally, bonds issued in local currencies can be used as a hedging tool, if you worry about the currency risks.
Usually, investors monitor the yield of US Treasuries vs. emerging market bonds. They look for the extra yield, or the spread widening that the bonds can offer. The higher the emerging market yield compared to the Treasuries, the more profitable the investment becomes. The rapid growth of the developing economies ensures the bonds yield and enhance returns.
If you make up your mind and decide to invest in emerging market bonds, you should know that there are some limitations. In some cases, you can’t invest directly in the emerging market bonds. However, there are numerous emerging market fixed income funds you can choose from. They offer a diversified mixture of global bonds both denominated in dollars, or in local currencies. Your challenge is to choose, which variant is yours.