EM High Yield Show Strong Performance — Evening Brief – 10.25.24
The rationale for international diversification from the perspective of a US investor typically revolves around the process of establishing a global equity allocation. In contrast, allocations to global bonds are frequently overlooked. However, after evaluating year-to-date performance for bonds outside the U.S., investors may be prompted to reassess their holdings.
Bonds rated below investment grade issued by corporations in emerging markets are significantly outperforming this year, according to a selection of ETFs. The iShares J.P. Morgan EM High Yield Bond ETF (EMHY) has gained 12.1% year-to-date as of Tuesday’s close.
This represents a substantial premium compared to other options, such the Vanguard Total International Bond ETF (BNDX) and the BlackRock iShares Core U.S. Aggregate Bond ETF (AGG). Furthermore, the surge in HYEM is outpacing the increase in the iShares iBoxx $ High Yield Corporate Bond ETF (HYG), with respective gains of 12.1% and 7.8%.
Multiple factors are benefiting emerging market junk bonds, beginning with a dovish shift in the U.S. interest-rate cycle. If the September rate cut signifies the commencement of a new and aggressive easing campaign, the transition is favorable for developing markets, which are very responsive to changes in U.S. interest rates.
“Eventually EM local-currency bonds should benefit from global easing,” said Anders Faergemann, a senior portfolio manager at Pinebridge Investments. “However, from a total return perspective, the relief rally in the U.S. dollar and domestic delays to monetary policy easing may have triggered some profit-taking.”
Although the US dollar has recently rebounded, it is still significantly below its spring peak, as indicated by the Dollar Index (DXY). After accounting for the conversion factor, a weaker dollar leads to larger foreign assets.
One could argue that while emerging junk yields are higher this year, it is unclear whether diversifying into non-dollar high-yield assets makes sense over longer time horizons. When HYG and HYEM are compared over the last five years, the latter underperforms a US high yield portfolio while being more volatile.
The question is whether the HYEM’s strong performance so far in 2024 marks the beginning of a cycle for emerging high yield bonds. For now, investors believe so.