One of the best things about the fixed income asset class is the sheer amount of choice. Investors have a wide range of options when it comes to finding bonds and steady income. Despite this fact, many investors tend to focus on only a few different sub-sectors of the market, leading to several potential opportunities falling through the cracks.
One of those could lie within the corporate bonds of firms located in emerging markets (EMs).
EM corporate bonds offer plenty of diversification benefits, high yields, and, in many cases, investment-grade credit ratings. And yet, investors completely ignore them in their portfolios. However, thanks to the growth in exchange traded funds (ETFs), investors don’t need to do that anymore.
Emerging Market Corporate Bonds?
When it comes to emerging markets like China, Brazil or India, investors generally get their fix through equities and are often seen as a capital gains component. However, these developing nations also feature a wide ecosystem of fixed income securities. Savvy, institutional, and high-net-worth investors have been tapping EM sovereign bonds for decades.
But just like the Indian government needs to raise money, so do corporations. And the market for bonds issued by corporations domiciled within EM nations has grown rather quickly. According to asset manager Schroders, issuance of bonds by EM corporations has grown at an annual clip of 21% since the 2000s. Today, the universe is diverse with nearly 760 issuers and bonds worth over $1.11 trillion. To put that into context, the size of the EM corporate bond universe is just slightly smaller than the entire U.S. junk bond market.
And while junk/high yield bonds are portfolio staples, EM corporate bonds are completely ignored from portfolios, with retail investors owning basically none.
Big Benefits
The shame is that these bonds offer plenty of benefits to portfolios.
One of those benefits is high yields. Thanks to their higher risks, bonds issued by EMs—either governments or private corporations—often pay higher coupons than those domiciled in developed nations. There’s a big yield disparity as well when comparing bonds issued by the government versus a corporation. After all, China can tax its way out of a problem and keep its bonds whole, whereas a U.S. auto manufacturer not so much.
As a result, investors can pick up additional yields over U.S. and developed market corporate bonds. Analysis from Schroders shows the additional yield to be had with various EM corporate bond sectors. That extra yield could be worth as much as an additional 3.1 percentage points. 1
The best part is that investors aren’t sacrificing credit quality. Despite the moniker of ‘emerging’, they feature investment-grade ratings. Default rates for investment-grade EM corporates are around 1%, equal to those in the developed world. At the same time, free cash flows continue to rise for many EM corporate debt issuers. The stocks in the MSCI Emerging Markets Index managed to see a 4.2% increase to their free cash flows last year. Analysts predict a similar 4.6% jump to free cash flows for all of 2024. That’s a lot of extra wiggle room to repay bonds, particularly when issuance of new bonds is down this year.
Another benefit could be equity-like returns without the volatility. Emerging market equities are known for their volatility. However, EM corporate bonds can offer similar returns without the ups and downs of the stocks. Data shows that over the past decade, EM corporates have delivered nearly 3% a year more in returns than EM equities with just 25% of the volatility. Moreover, EM corporate bonds could provide plenty of low correlation to existing bond portfolios, offering very low correlation to U.S. Treasuries.
Adding Some EM Corporate Bond Muscle
Given the extra yield, diversification benefits, lower volatility, and all-around positives, investors may want to add a dose of EM corporate bond muscle to their portfolios. The best part is adding these bonds is a snap these days.
Previously, unless investors were very large or had direct access to an investment bank’s fixed income desk, ownership was nearly impossible. These days, however, it can be as simple as buying a single ETF. Investors can choose between investment-grade or high yield credit ratings. Moreover, some larger EM bond ETFs include both sovereigns and corporate debt.
Emerging Market Corporate Bond ETFs
These funds were selected based on their sole exposure to EM corporate bonds. They are sorted by their YTD total return, which ranges from 0.50% to 2.80%. They have expenses between 0.40% to 0.60% and have assets under management between $40M and $422M. They are currently yielding between 4.7% and 6.3%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| HYEM | VanEck Emerging Markets High Yield Bond ETF | $371M | 2.8% | 6.3% | 0.40% | ETF | No |
| EMCB | WisdomTree Emerging Markets Corporate Bond Fund | $40M | 0.90% | 4.7% | 0.60% | ETF | Yes |
| CEMB | iShares Emerging Markets Corporate Bond ETF | $422M | 0.50% | 4.82% | 0.50% | ETF | No |
All in all, EM corporate bonds can offer plenty of benefits to a portfolio. While the segment is small, it is growing. And given the advantages, it should grow even further. Smart investors will take notice today.
The Bottom Line
Emerging market corporate bonds offer a great opportunity for investors. With bigger yields, diversification, and lower volatility, they can offer strong in-roads into emerging markets and offer a great fixed income complement.
1 Shroders (November 2023). Unveiling the Value of Emerging Markets corporate bonds