Like high-yield bonds, emerging market debt is an asset category for investors who are willing to stomach above-average credit risk in the quest for higher longer-term returns. On the spectrum of risk and reward, emerging market bonds fall in between investment-grade corporate bonds and high-yield bonds. Emerging market debt should, therefore, be considered a longer-term investment that isn’t suitable for someone whose top priority is the preservation of capital.
Example of Emerging Market Bonds
Let’s say you bought an emerging market bond from Mexico. The issuer of the bond is Mexico, and it’s a 10-year bond (MBONOS). The face value is 100 pesos (about $5.02, as of October 2022). You’re paid interest every six months, and after 10 years, you receive your principal investment back, plus all of the interest you earned during that time. One easier way to invest in an emerging market bond is through an ETF. For example, the iShares J.P. Morgan USD Emerging Markets Bond ETF gives investors exposure to U.S. dollar-denominated emerging market bonds. On Sept. 30, 2022, the end of the third quarter of that year, this ETF had a total return of 3.26% since its inception.
Performance of Emerging Market Bonds
Emerging market bonds have evolved from being an extremely volatile asset class in the early 1990s to a large, more mature segment of the global financial markets today. Emerging nations have gradually improved in terms of political stability, the financial strength of the issuing countries, and the soundness of government fiscal policies. While a number of developed nations still struggle with budget deficits and high debt, many developing countries feature sound finances and more manageable levels of debt. Additionally, developing countries—as a group—can enjoy stronger rates of economic growth than their developed-market peers.
Emerging market bonds remain vulnerable to external shocks that weaken investors’ appetite for risk. The asset class, therefore, remains volatile despite the fundamental improvements in the economies of the underlying nations.
Who Issues Emerging Market Bonds?
A large number of countries issue emerging market bonds for investors to buy. For example, you can buy bonds or invest in bonds from countries like Argentina, Brazil, and Mexico.
How To Invest in Emerging Market Bonds
Investors can choose between mutual funds and exchange-traded funds (ETFs) that invest in either dollar-denominated emerging market debt or debt issued in local currencies. For example, in issuing debt, a country such as Brazil can sell bonds denominated either in dollars or the country’s currency—the real. Dollar-denominated debt tends to be more stable, while local currency debt is generally more volatile. However, local currency debt can, in the longer term, provide another way to capitalize on the strong economic growth and finances of emerging market countries. The option you choose depends on your tolerance for risk. Investors aren’t limited to just government bonds in emerging markets. Corporations in developing countries also issue debt and this asset class is rapidly growing in popularity. While many emerging market funds put a portion of their assets in corporate bonds, investors can also access the asset class directly through ETFs such as WisdomTree Emerging Markets Corporate Bond Fund (EMCB).
What Emerging Market Bonds Mean for Investors
Emerging market bonds can provide diversification for those with bond portfolios that have more of a U.S.-centric focus. Emerging economies don’t always move in tandem with developed economies, which means that the bond markets of the two groups can also provide divergent performances. Be aware, however, that the asset class can mirror the performance of the world stock markets. As a result, it can provide a measure of diversification for someone whose portfolio is heavily tilted toward stocks, but not as much as you might expect.
