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Why Now May Be the Right Time for Emerging Market Bonds

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Source: BlackRock as of 5/9/2014For more information on S&P fund credit ratings, please click here .

At the far left of the graph is the iShares Aaa-A Rated Corporate Bond ETF, QLTA . This fund primarily provides exposures to securities with ratings of A or higher. At the far right of the graph is the iShares B-Ca Rated Corporate Bond ETF, ( QLTC ). This fund provides exposure to the lower credit quality segments of the high yield market, and because of the level of credit risk in the fund, it offers the highest yields of the group.

So where does EM debt fit into the risk versus return landscape? Typically EM lies somewhere in the middle, as the EM bond universe contains a combination of investment grade (Chile, Malaysia, Mexico and others) and high yield (Ukraine, Argentina, Venezuela) issuers. This changed in May/June 2013 as investors became concerned about credit risk and yield spreads widened in response. Since that time we have seen a steady tightening of investment grade and high yield credit spreads across the board as investors have moved back into those sectors. EM spreads have tightened some as well, but not nearly as much. As a result, the yields on EM debt appear to be unusually wide given the credit quality of the issuers. EM credit spreads are trading near those for the high yield market, even though almost 70% of the EM issuers in a broad EM vehicle, like the iShares Emerging Markets USD Bond ETF ( EMB ), are investment grade.

Source: BlackRock as of 5/9/2014 For more information on S&P fund credit ratings, please click here .

The above chart highlights the divergence in spreads that has occurred since 2012. The question for investors today is, will EM rally versus corporate bonds? It's hard to say. Keep in mind that part of what is keeping EM wide is that the universe, and in particular EMB, include exposure to the debt of countries that have dominated headlines lately. This includes Russia, which makes up 5.61% of EMB, Ukraine which makes up 2.85%, and Brazil which makes up 6% (Source: BlackRock as of 5/1/2014). It is certainly possible that EM debt can remain at elevated spread levels if we continue to see political and economic challenges in the issuing countries. At the same time we are seeing some investors move back into the sector as evidenced by the $584 million of flows into EMB this year through May 1 st (Source: Bloomberg). Bottom line, for investors looking to add yield to a portfolio, EM debt may be an alternative they should take a closer look at. Just remember that, as always, yield isn't free. Matt Tucker, CFA, is the iShares Head of Fixed Income Strategy and a regular contributor to the The Blog. You can find more of his postshere .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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