Yields still make emerging market debt an option amid strong dollar

Rising interest rates amid US central bank tightening decimated both equities and bonds in emerging markets (EM). Nevertheless, for the latter, emerging market bonds offer bond investors a way to earn more yield.

In the meantime, emerging market investors will continue to watch how the US Federal Reserve adjusts its monetary policy to keep inflation in check. The prevailing notion is that further tightening will take place, which could further sour bond sentiment, but in turn, yields could push higher.

“Compared to other currencies, the US dollar is the strongest it has been in two decades,” said a New York Times article mentioned. “It’s rising because the Federal Reserve has raised interest rates sharply to fight inflation and because America’s economic health is better than most.”

“Together, these factors have attracted investors from around the world,” the New York Times article added. “Sometimes they’re just buying dollars, but even if investors are buying other assets, like government bonds, they need dollars to do it — in each case, driving up the value of the currency.”

One way to fight rising interest rates is to simply seek more yield. Emerging market debt offers attractive return options if bond investors are willing to accept more risk, which could be mitigated by opting for government bonds.

Gain diversified exposure to emerging markets

A convenient way to gain exposure to emerging market bonds with a focus on safer government bonds, exchange-traded funds (ETFs) can offer this level of exposure. A fund to consider is the Vanguard Emerging Markets Government Bond Index Fund ETF Shares (VWOB).

VWOB seeks to track the performance of a benchmark index that measures the investment performance of US dollar-denominated bonds issued by governments and government-related issuers in emerging countries. The fund uses an index investing approach designed to track the performance of the Bloomberg Barclays USD Emerging Markets Government RIC Capped Index.

Exposure to emerging market debt comes with an expense ratio of 0.20% for VWOB. For that, the fund comes with a 30-day SEC yield of just over 7% as of October 3.

The average duration of the fund’s holdings is around seven years, giving the fund mid-level exposure to help capture yield while limiting duration risk. In terms of country allocations, the top three are made up of Mexico, Saudi Arabia and Indonesia.

For more news, insights and strategy visit the Fixed income channel.

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