Although US interest rates are poised to rise, government bond yields in developed markets, including Canada, will still remain relatively low – in some cases lower than the rate of inflation – resulting in negative real rates of return. This means investors will theoretically lose money by investing in traditionally safe, high-quality government bonds.
That’s the conundrum income-seeking investors are facing today. However, there is a solution. Investing in investment grade emerging markets (EM) corporate and sovereign bonds will not only provide significantly higher yields but also offer portfolio diversification.
And they are no longer as risky as they used to be some 10 to 15 years ago. “Currently, 63% of EM bonds are rated investment grade, compared to less than 20% ten years ago,” says David Kunselman, senior portfolio manager with Excel Investment Counsel Inc. “EM countries are experiencing significant improvements in their credit ratings, translating to ratings upgrades on their bonds,” he says.
Adds Sergei Strigo, Head of Emerging Markets Debt at Amundi Asset Management and Portfolio Manager of the Excel High Income Fund, the structure of emerging market economies have changed, they are now fundamentally much stronger with a debt to GDP ratio of less than 50%. For instance, “there were no banking crises in emerging markets during the 2007-08 financial crisis, as we saw in the US and Western Europe,” he says – which attests to the strength of EM economies.
EM bonds also offer diversification, says Kunselman. “There are now more than 60 different countries issuing bonds, providing investors with exposure to different countries and regions with varying economic conditions.”
A good way to get exposure to high yield emerging market bonds is by investing in a fund like the Excel High Income Fund which provides access to a diversified portfolio of sovereign and corporate EM bonds. The fund provides an annual income distribution of approximately 5.7%, which is 5 times greater than the average 3- to 5-year yields provided by Government of Canada Bonds. And it is rated four-star by Morningstar Canada,
High-yield bond funds also typically require expert management to navigate credit, interest rate and currency risks. The Excel High Income Fund is managed by Amundi Asset Management, one of the largest asset managers with more than $1 trillion in assets under management.
High yield bonds “have had an incredible run” over the past few years but the “rewards are extremely attractive” and “it’s not too late to invest,” says Strigo. “Year-to-date USD $50 billion have flowed into EM debt,” he adds.