Finding Higher Yield in Emerging Market Bonds
ILLUSTRATION BY JONAN EVERETT
Featured image art by Jonan Everett.
Millennials have a higher risk tolerance and a longer time horizon to invest for retirement. So for many millennials, adding emerging market bonds to the fixed-income portion of their allocations can be an effective diversifier. Emerging markets — such as Brazil, China, and India — are not as advanced as developed countries like the U.S. However, they have growing economies and often offer promising investment opportunities.
“From a fixed-income perspective, emerging market bonds have been more volatile in terms of price action. But generally they come with a higher yield, much like high-yield corporate bonds,” says Ryan Mohr, a certified financial planner in Tigard, Oregon.
Why Should You Invest in Emerging Market Bonds?
Inflation and rising interest rates, combined with some revisions to the U.S. tax code, make emerging market bonds particularly attractive now, experts say.
“By investing in bonds based in emerging market economies where there’s lower inflation, investors expect to be compensated through higher yields for taking additional risk with default, unlike U.S. treasuries, which are backed by the government,” says Mohr, who is also the founder of Clarity Capital Management. Many emerging markets are currently experiencing lower rates of inflation.
Gaining broad exposure across a mix of countries and economies is key. For example, Edward Kohlhepp, a certified financial planner in Doylestown, Pennsylvania, uses mutual funds to gain access to high-yielding emerging market bonds. (Many companies, such as Worthy, offer interest rates of as much as five percent.)
“A good manager in this category has substantial boots on the ground in order to assess the various risks, such as geopolitical and currency risks,” Kohlhepp says.
Mutual Funds and ETFs
In addition to considering mutual funds when seeking to add the foreign asset class to their portfolio, Mohr urges millennials to explore exchange-traded funds, or ETFs, as opposed to purchasing individual emerging market bonds.
“Mutual funds and ETFs that invest in a basket of emerging market bonds offer liquidity and diversity across countries and maturities; and they will be much easier and simpler to trade,” Mohr says.
Plus, there are funds available that allow investors to buy both local-currency and U.S. dollar–denominated debt. These give investors a way to hedge against currency fluctuations.
Studying the investment strategy of an emerging market bond ETF or mutual fund can shed light on how it may react to different currency and market environments.
Be prepared for taxes on income generated throughout the year by the emerging-market fund or ETF. You may also have tax implications from short- or long-term capital gains or losses generated from the sale of holdings within the fund, and ultimately from any gain or loss from the purchase price when you sell your fund shares.
“If you hold emerging market bonds in your retirement account, there wouldn’t be any tax considerations until, of course, you made a withdrawal,” Mohr says.