Why Emerging Markets Bonds Offer More Than Just Higher Risk Premiums. It is time to think about a strategic allocation to emerging markets bonds, according to William Sokol, Product Manager at VanEck. Increasing strategic allocation to emerging markets bonds promises more benefits that just higher risk premiums. As the asset class continues to grow both in size and diversity, emerging markets bonds can boost income producing potential and provide unique diversification.
Low correlation offers unique diversification
“An analysis of the past ten years shows that emerging markets bonds generally exhibit moderate correlation to other core fixed income asset classes,” Sokol explains, “particularly when compared to U.S. equities.” While the correlation between U.S. high yield bonds and U.S. equities is 0.73, local currency emerging market bonds correlate only 0.62. Even U.S. dollar-denominated emerging market bonds exhibit only a correlation of 0.58 to U.S. equities. The correlation is slightly higher for emerging markets high yield bonds at 0.67. “The generally lower correlation of emerging markets bonds to U.S. equities can indicate a higher potential for diversification within an investor’s credit portfolio.”
Emerging markets bonds boost income producing potential
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 percent. To compare: The YTW of U.S. high yield bonds was 6.12 percent. With an YTW of 6.65 percent, emerging markets local sovereign bonds came in second.
