Leveraging Emerging Debt to Improve Income Profiles
Yeses, the Federal Reserve raised interest rates last week, and yes, more rate hikes are coming. However, yields on high-quality domestic government bonds are still low and are expected to remain so for some time.
This point highlights why some investors may want to consider international debt, including emerging market bonds. Exchange-traded funds, such as American Century Emerging Markets Bond ETF (AEMB)facilitate access to what can be a difficult asset class to navigate.
AEMB, which debuted last July, holds dollar-denominated sovereign and quasi-sovereign debt as well as corporate bonds. The fund could be an attractive choice for income investors this year, as emerging market powerhouses have already raised interest rates in 2021, indicating that many of their tightening cycles could end in 2022.
“We believe emerging market debt is going to be a key pillar of this investment to help investors achieve these goals,” William Blair’s Jared Lou said in an interview with Institutional Investor’s Mike Corcoran. “Low base rates make it even harder to see outsized returns from fixed income portfolios in the future. Therefore, we believe emerging market debt must be an important part of the solution.
The AEMB is actively managed, and this is significant in several respects. The fund had a 4% weighting in Russian bonds as of February 28, but the exposure may have since been reduced or eliminated. Additionally, emerging market fixed income securities are a prime example of an asset class where active management can benefit investors, as fund managers can seek out attractive credit opportunities while mitigating interest rate risk.
“With the Federal Reserve keeping base rates so low, they’re encouraging you to take more risk, and they’re providing excessive support to many economies to refinance their debt at lower rates, which we think will reduce credit losses in the future, so emerging market debt has the potential to be a more attractive asset class in this low rate environment,” Lou added.
AEMB allocates 37% of its weight to Mexico, Brazil, Indonesia and Colombia. The American Century ETF sports an option-adjusted duration of 6.8 years, putting it in medium-term territory. Around 88% of the fund’s 102 holdings are rated BBB, BB or B and around 39% are corporate bonds.
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