What are emerging market bonds?

Definition:

Emerging market bonds are fixed-income investments issued by governments or companies from countries that are not considered developed countries.

How do emerging market bonds work?

Emerging market bonds are considered high-risk, meaning they may offer higher returns but also carry larger losses. Smaller and less developed countries are seen as more vulnerable to severe economic fluctuations, political upheaval, and other unusual events in developed financial markets.

Like high-yield bonds, emerging market debt is an asset class for investors willing to take on above-average credit risk in search of higher long-term returns. In terms of risk and reward, emerging market bonds lie between investment-grade corporate bonds and high-yield bonds. Therefore, emerging market debt should be viewed as a long-term investment that is not suitable for those who prioritize capital preservation above all else.

Example of emerging market bonds

Suppose you bought emerging market bonds from Mexico. The issuer of the bond is Mexico, and it is a 10-year bond (MBONOS). The bond’s face value is 100 pesos (approximately $5.02 as of October 2022). You will receive interest every six months, and after 10 years, you will receive your original capital investment, plus all the interest earned during that period.

An easier way to invest in emerging market bonds is through an exchange-traded fund (ETF). For example, the iShares J.P. Morgan USD Emerging Markets Bond ETF provides investors with the opportunity to invest in dollar-denominated emerging market bonds. As of September 30, 2022, at the end of the third quarter of that year, this fund had a total return of 3.26% since its inception.

Note: It is important to keep in mind that emerging market bonds are also subject to more volatility than most other securities in the fixed income universe. This may not be a top priority for those investing for the long term.

Performance of emerging market bonds

Emerging market bonds have evolved from being a highly volatile asset class in the early 1990s to a substantial and more mature sector in today’s global financial markets. Emerging countries have gradually improved in terms of political stability, financial strength of the issuing countries, and the health of government fiscal policies. While many developed countries still struggle with budget deficits and high debt levels, many developing countries enjoy healthy financial resources and lower manageable debt levels. Additionally, developing countries – as a group – can experience stronger economic growth rates than their peers in advanced markets.

Who issues emerging market bonds?

A large number of countries issue emerging market bonds for investors to purchase. For example, you can buy bonds or invest in bonds from countries such as Argentina, Brazil, and Mexico.

Note: If you are interested in purchasing a bond from a specific country, you can check if the country issues it by researching online. Just be sure to read from a reliable site and do not give your money or any personal information to anyone if you are not sure they can be trusted. Talk to a financial professional before investing.

How to invest in emerging market bonds

Investors can choose between mutual funds and exchange-traded funds (ETFs) that invest either in dollar-denominated emerging market debt or debt issued in local currencies. For example, a country like Brazil can sell bonds in dollars or its currency – the real. Dollar-denominated debt tends to be more stable, while debt denominated in local currencies is generally more volatile. However, local currency debt can, in the long term, provide another way to capitalize on strong economic growth and financial opportunities in emerging countries. The choice you make depends on your risk tolerance.

Not

Investors are limited to government bonds only in emerging markets. Companies in developing countries also issue debt, and this asset class is rapidly gaining popularity. While many emerging market funds allocate part of their assets to corporate bonds, investors can also access the asset class directly through exchange-traded funds such as the WisdomTree Emerging Markets Corporate Bond Fund (EMCB).

What Do Emerging Market Bonds Mean for Investors?

Emerging market bonds can provide diversification for those with bond portfolios that are more heavily focused on the U.S. Emerging economies do not always move in parallel with developed economies, meaning that the bond markets in both groups can provide divergent performance.

However, you should be aware that the asset class can reflect the performance of global equity markets. As a result, it can provide a degree of diversification for someone with a portfolio significantly tilted toward stocks, but not to the extent you might expect.

Frequently Asked Questions (FAQs)

Why are emerging market bond yields usually high?

Emerging markets typically have government bonds with high yields due to the risks that investors take on. While government bonds in the U.S. are typically backed by guarantees, emerging market bonds may not be, meaning you might not receive your principal or interest payments at the end of the term.

Why might an emerging market bond issuer fail?

An emerging market bond issuer might fail due to political, economic, or cultural risks and events. If a country’s financial market is unstable, it could be affected by unforeseen circumstances, potentially leading to defaults on what is owed to bondholders.

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Sources:

The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.

FINRA. “Bonds: Types.”

Board of Governors of the Federal Reserve System. “Differential Treatment in the Bond Market: Sovereign Risk and Mutual Fund Portfolios.”

The Mexican Government Securities Market. “II. Types of Instruments and Their Placement.”

iShares. “iShares J.P. Morgan USD Emerging Markets Bond ETF.”

Board of Governors of the Federal Reserve System. “Brady Bonds and Other Emerging Market Bonds.”

S&P Dow Jones Indices. “Fixed Income 101: Mexico.”

WisdomTree. “EMBC: WisdomTree Emerging Markets Corporate Bond Fund.”

Source: https://www.thebalancemoney.com/introduction-to-emerging-market-bonds-417021