Fixed income investors know that 2022 has been tough for domestic bonds. Seven interest rate hikes by the Federal Reserve will achieve this, but the turbulence has not been limited to US fixed income assets.
Largely due to the surge in the dollar following these rate hikes, dollar-denominated emerging market bonds fell. Down 20.16% since the start of the year, the Vanguard Emerging Markets Government Bond Index Fund ETF Shares (VWOB) paints a picture of emerging market debt weakness.
However, some market watchers think the new year could bring better things for emerging market debt, indicating that VWOB could be a high-yield rebound idea worth considering by income investors.
“We also stick to credit rather than equities in emerging markets (EM). Emerging market debt has outperformed emerging market equities by 395% since 1991,” notes Bank of America. Emerging market equities remain elevated Emerging market debt has only been in a bear market 4.5% of the time over the past 30 years, compared to 33% of the time for emerging market equities. emerging markets also only have 2-4% direct exposure to China.”
VWOB, which tracks the Bloomberg USD Emerging Markets Government RIC Capped Index, holds 754 bonds, none of which represents more than 0.64% of the ETF’s portfolio. The $3 billion ETF stands to benefit if the dollar depreciates next year – a relevant point as the bonds held by VWOB are denominated in US currency.
“Our currency strategists also expect The US dollar will peak in 1Q23, which should help alleviate default issues. Jane Brauer waits 11% return for emerging debt Next year. We prefer emerging market external debt, which has outperformed local currency bonds by 4.25% per year since 2013,” added Bank of America.
VWOB has an average duration of 7.4 years, putting it firmly in mid-term territory. This classification has certain advantages, including the potential for reduced correlations with equities and longer-dated bonds.
Another possible advantage that could accrue to VWOB next is that some emerging market central banks could withhold rate hikes because they started their rate-tightening regimes before the Federal Reserve. Additionally, VWBO reports an attractive 4.76%. This is compelling not only from a revenue perspective, but also because of historical precedents.
“EM debt yields (7%) also look relatively attractive relative to the volatility. Buying yield/steal spikes has historically resulted in double-digit returns over the subsequent 12 and 24 months,” concludes Bank of America.
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Opinions and predictions expressed herein are solely those of Tom Lydon and may not materialize. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.
