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Tuesday, August 29, 2017

Emerging Market Bonds An Asset Class I Never Liked,....And Current Markets Make Them Even Less Atrtactive


I never understood the appeal of Emerging Market bonds which have become popular in ETFs and in allocations recommendations and in the allocation of some of the "robo advisors".

It's clear that the interest in this asset class came in the "search for yield"..but what a terrible place to look. In order to get the extra yield compared to US treasuries and corporate bonds investors took on the currency (even if the index is denominated in dollars the countries must convert local currency to dollars to pay the debt, economic and political risk associated with some of the weakest economies in the world.

The indices are weighted according to the size of country allocations relative to the emerging market bond markets as a whole. The more debt the larger the allocation, So unlike the emerging market stock index which is based on market capitalization and thus skews towards higher allocation the emerging market bond index is quite the opposite.

In my post on emerging market stocks I noted the outperformance of Asia vs. Latin America. Most of  the countries emerging Asia is not included in the index while virtually all of Larin America is . And China, close to 50% of the stock index is only 3.79% of the bond index. Would you really want a bond portfolio with 3.13% in bonds from Kazakhistan (isnt that where Borat was from ?)


Here is the country allocation for EMB the largest emerging markets ETF








If bonds are to be the more stable part of a portfolio then it doesn't make much sense to me to hold emerging market bonds...and if one is looking for exposure to emerging market growth it is much better done through emerging market stocks.

And if emerging market bonds were unattractive as a place to reach for yield...the case is even weaker for emerging markets than ti might have been in the past.

While I wouldn't base my decision on the words of any market gurus, sseveral of the more prominent fixed income managers have been reducing their emerging market bond holdings seeing the asset class as overvalued.

Looking at market yields it is hard to disagree. EMB the emerging market bond ETF now has a 30 day yield of 4.48%. The short term high yield bond ETF SJNK described in an earlier post is yielding 5.01%. It is hard to look at the country distribution above with a 7 year duration as a better investment than short term USD high yield.

Robo Alert: Both Wealthfront and Betterment include an allocation to emerging market bonds



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