Why emerging market bonds?

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Schlabba
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Why emerging market bonds?

Post by Schlabba » Mon Oct 07, 2019 1:55 pm

Hi Bogleheads,

When I go to the iShares and Vanguard websites and look for bonds, sorted by AUM, EM bonds seem to be very very popular.
  • The Vanguard USD Emerging Markets Government Bond UCITS ETF (USD) Distributing (VDET) has a YTM of 4.5%
  • iShares J.P. Morgan $ EM Bond UCITS ETF has a YTM of 4,74%
And we are actually talking about USD-based Government bonds! Not junk or corporate bonds. I happen to know Argentina defaults on a regular basis but governments seem rather safe. There is even an iShares version which hedged to the EUR.

Do you guys use these? Does this hold any place in a portfolio? Howmuch risk would you guess these to be? Or in other words: Why are these so popular?

The standard-deviation seems to be somewhere in between my current "safe" bonds and the MSCI World.
4.5% return with low risk seems like I should be loading up on these...

Edit: I just found some reading material: https://advisors.vanguard.com/iwe/pdf/I ... IL:ET:2017
IWDA: MSCI World | EMIM: MSCI Emerging Markets | AGGH: Global Aggregate Bond Hedged to €

GermanDoc
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Re: Why emerging market bonds?

Post by GermanDoc » Mon Oct 07, 2019 3:04 pm

With a lump sum coming in soon I plan to add EM bonds as a 7% holding to my 70/30 3 fund portfolio as part of the 'equity' side.

https://www.ifw-kiel.de/de/experten/ifw ... -waterloo/

A long read, but with good data.

Regarding hedging to EUR, any opinions whether it's worth it?

I go with hedging my global bonds, since they are for stability.
But I don't know about the EM USD bonds.

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Schlabba
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Re: Why emerging market bonds?

Post by Schlabba » Mon Oct 07, 2019 3:17 pm

GermanDoc wrote:
Mon Oct 07, 2019 3:04 pm
With a lump sum coming in soon I plan to add EM bonds as a 7% holding to my 70/30 3 fund portfolio as part of the 'equity' side.

https://www.ifw-kiel.de/de/experten/ifw ... -waterloo/

A long read, but with good data.

Regarding hedging to EUR, any opinions whether it's worth it?

I go with hedging my global bonds, since they are for stability.
But I don't know about the EM USD bonds.
Thanks for the link, I'll read it now!

After reading the vanguard paper they are clearly on the equity side, which means I won't hedge them. (iShares Euro hedged has a TER 0.50% but the unhedged Vanguard etf has a TER of 0.25%).

Edit: 78 pages, I'll read it later :wink:
IWDA: MSCI World | EMIM: MSCI Emerging Markets | AGGH: Global Aggregate Bond Hedged to €

PolarInvest
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Re: Why emerging market bonds?

Post by PolarInvest » Mon Oct 07, 2019 3:24 pm

These definitely belong on the equity side, but I think they offer good diversification. For example, they provide equity-like returns, but only declined by about 24% in 2008-09. Obviously they will do worse at other times when US and Int'l Developed stocks do relatively less worse, like in the 1996 currency crisis.

I use them to replace my EM stock allocation, since my belief is that many of the large EM companies in VWO are quasi-state enterprises that can't be valued accurately in any fundamental sense and are subject to political considerations that you'd have to be an insider to quantify accurately. No complaints so far.

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Re: Why emerging market bonds?

Post by vineviz » Mon Oct 07, 2019 3:31 pm

PolarInvest wrote:
Mon Oct 07, 2019 3:24 pm
These definitely belong on the equity side, but I think they offer good diversification. For example, they provide equity-like returns, but only declined by about 24% in 2008-09. Obviously they will do worse at other times when US and Int'l Developed stocks do relatively less worse, like in the 1996 currency crisis.

I use them to replace my EM stock allocation, since my belief is that many of the large EM companies in VWO are quasi-state enterprises that can't be valued accurately in any fundamental sense and are subject to political considerations that you'd have to be an insider to quantify accurately. No complaints so far.
I pretty much agree.

I wouldn’t replace all the emerging markets equity with EM bonds, but certainly endorse replacing some of it. I use a local currency EM bond fund as roughly 1/3 to 1/2 of my total emerging markets equity exposure.

The country concentration of the equity fund differs from the bond fund, which is where much of the diversification benefits come from.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Why emerging market bonds?

Post by oogZoo » Mon Oct 07, 2019 4:29 pm

There are also emerging markets local currency bonds in case you do not want to increase your USD exposure.

For example:
  • IE00BFZPF546 iShares J.P. Morgan EM Local Govt Bond UCITS ETF
  • IE00BFWFPY67 SPDR Bloomberg Barclays Emerging Markets Local Bond UCITS ETF
Just an idea in case you didn't notice these.

Northern Flicker
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Re: Why emerging market bonds?

Post by Northern Flicker » Mon Oct 07, 2019 4:38 pm

EM bonds should not be part of your safe bond allocation and certainly you can construct an effective portfolio without them at all.
Last edited by Northern Flicker on Mon Oct 07, 2019 6:31 pm, edited 1 time in total.
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Re: Why emerging market bonds?

Post by nisiprius » Mon Oct 07, 2019 5:24 pm

They have been high-risk, high return. They haven't been bond-like at all. Some people will always be attracted by high return. I think the view of emerging market bonds is colored by the fact that it is now more than 10 years since this happened, and most emerging market bond funds are less than ten years old... and those that are more than ten years old aren't required to include this time period in the standard descriptive materials, and usually don't.

This is Fidelity's emerging markets bond fund, FNMIX. That's a -40% loss, in a "bond" fund. The recovery was quick, the return since then has been good as you can see by clicking on "source" and picking "max," and some people are convinced this was a one-time event that couldn't possibly recur. But. -40%.

Source

Image
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Re: Why emerging market bonds?

Post by unclescrooge » Mon Oct 07, 2019 7:21 pm

PolarInvest wrote:
Mon Oct 07, 2019 3:24 pm
These definitely belong on the equity side, but I think they offer good diversification. For example, they provide equity-like returns, but only declined by about 24% in 2008-09. Obviously they will do worse at other times when US and Int'l Developed stocks do relatively less worse, like in the 1996 currency crisis.

I use them to replace my EM stock allocation, since my belief is that many of the large EM companies in VWO are quasi-state enterprises that can't be valued accurately in any fundamental sense and are subject to political considerations that you'd have to be an insider to quantify accurately. No complaints so far.
why not invest in a fund that excludes state-owned enterprises. Just off the top of my head, i can think of two such ETFs, XSOE and CXSE.

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Re: Why emerging market bonds?

Post by QuantOfAsia » Mon Oct 07, 2019 7:24 pm

EM USD bonds are no substitute for equity, since at most they pay you back principal+interest. Some of the bonds are investment grade and others high yield, and so I place these I'm my bond buckets accordingly. Combined with purely corporate high yield, these bonds provide some issuer diversification.

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Re: Why emerging market bonds?

Post by rich126 » Mon Oct 07, 2019 9:14 pm

FYI. FNMIX manager John Carlson is retiring at the end of the year.

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Re: Why emerging market bonds?

Post by JAZZISCOOL » Mon Oct 07, 2019 10:22 pm

I have a small allocation to emerging market debt (EMD) in my fixed income allocation for diversification purposes and because it has a slightly higher expected return. Volatility can be high during geopolitical events and other types of global economic crises so probably not for the investor who could not tolerate this in their portfolio.

In a 2018 JPMorgan capital markets assumption article I have (used for portfolio modeling), they use an expected return assumption of 5.25% for EMD (a 200 basis point premium to US Aggregate Bonds in 2018 which was 3.25%) with a correlation of 0.60 between EMD and US Aggregate Bonds. Volatility (standard deviation) assumptions used were 9.75% for EMD and 3.75% for US Aggregate Bonds.

The correlation between EMD and US Large Cap equities is 0.52 in the JPMorgan article.

JPMorgan’s emerging market debt ETF “EMB” is up 12.60% YTD (price return) while the AGG (US Aggregate Bonds) is up 8.32% YTD (price return; as of 9/30/19 per Schwab.) The local currency VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (“EMLC”) is up 4.35% YTD (price return; as of 9/30/19.)

YMMV.

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Re: Why emerging market bonds?

Post by Valuethinker » Tue Oct 08, 2019 5:31 am

nisiprius wrote:
Mon Oct 07, 2019 5:24 pm
They have been high-risk, high return. They haven't been bond-like at all. Some people will always be attracted by high return. I think the view of emerging market bonds is colored by the fact that it is now more than 10 years since this happened, and most emerging market bond funds are less than ten years old... and those that are more than ten years old aren't required to include this time period in the standard descriptive materials, and usually don't.

This is Fidelity's emerging markets bond fund, FNMIX. That's a -40% loss, in a "bond" fund. The recovery was quick, the return since then has been good as you can see by clicking on "source" and picking "max," and some people are convinced this was a one-time event that couldn't possibly recur. But. -40%.

Source

Image
Thank you for this history.

I remember Mexico going broke in the early 80s. Then again in 1994 when an obscure guerrilla "Commander Zero" wrote into a southern Mexican town and kicked off a meltdown. The EM Crash - stocks you had bought 6 months earlier halved, and halved again -- stocks across the world.

Then 1997-98 and the Thai crash - Contagion became a thing as countries fell like dominos. Thousands dead in Indonesian rioting. South Korean women lining up to have their wedding rings melted for gold to boost Central Bank reserves.

Then suddenly Russia and Brasil were at risk of default. And Russia did default, leading to the collapse of Long Term Capital Management hedge fund and that wonderful book "When Genius Failed" by Roger Lowenstein.

To us this stuff is numbers on a screen. In countries, literally life and death.

Of course Argentina and successive defaults. Argentina floated a 100 year bond at something like 8 7/8ths coupon only a couple of years ago.

Owning EM bonds exposes the investor to not only country credit risk, but also contagion risk. The crashes can be country specific, but they can also spread across to adjacent markets.

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Re: Why emerging market bonds?

Post by andrew99999 » Tue Oct 08, 2019 8:33 am

Thank you Valuethinker.
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Re: Why emerging market bonds?

Post by Valuethinker » Tue Oct 08, 2019 9:52 am

andrew99999 wrote:
Tue Oct 08, 2019 8:33 am
Thank you Valuethinker.
I am old enough to remember the 1970s and how it all seemed to be coming apart in the developed world.

Stagflation. Successive Oil Crises. Line-ups at the gas stations - fist fights and shootings in America. The 3 Day Week in Britain.

IRA - Belfast going up in flames. FLQ in Quebec and armed soldiers in the streets. State of Emergency. The Red Brigades kidnapping Aldo Moro (Prime Minister) in Italy and killing him. The Baader-Meinhof Complex in Germany rolling around kidnapping & killing seemingly indiscriminately. The Bologna train station bombing. The SLA & Patty Hearst. The Fall of Saigon and the helicopters on the US Embassy Chancery.

The Tehran Embassy Hostage Crisis. President Carter at 645 AM on the radio, saying the rescue mission had failed at Desert One.

The stock markets in the 1970s were torrid things. Rallies punctuated by bear markets. Inflation eating away at savings. People who retired on fixed incomes immiserated by inflation.

The next 2 decades seemed to presage a similar sort of roller coaster in Emerging Markets. Now you have the rise and rise of China but the question of the reality of the underlying earnings and GDP growth (the latter is widely understood to be a statistical fabrication, at least in recent years).

I can't quite believe that the days of Contagion are past us. Even though the market seems to distinguish much more selectively between countries.

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Re: Why emerging market bonds?

Post by Schlabba » Tue Oct 08, 2019 10:45 am

Thanks for the replies!

Now I am thinking that as long as the EM bonds are counted on the equity side, they provide some useful diversification without sacrificing too much returns.
IWDA: MSCI World | EMIM: MSCI Emerging Markets | AGGH: Global Aggregate Bond Hedged to €

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Re: Why emerging market bonds?

Post by Northern Flicker » Tue Oct 08, 2019 12:53 pm

unclescrooge wrote:
Mon Oct 07, 2019 7:21 pm
PolarInvest wrote:
Mon Oct 07, 2019 3:24 pm
These definitely belong on the equity side, but I think they offer good diversification. For example, they provide equity-like returns, but only declined by about 24% in 2008-09. Obviously they will do worse at other times when US and Int'l Developed stocks do relatively less worse, like in the 1996 currency crisis.

I use them to replace my EM stock allocation, since my belief is that many of the large EM companies in VWO are quasi-state enterprises that can't be valued accurately in any fundamental sense and are subject to political considerations that you'd have to be an insider to quantify accurately. No complaints so far.
why not invest in a fund that excludes state-owned enterprises. Just off the top of my head, i can think of two such ETFs, XSOE and CXSE.
Is being in competition with the state and state-owned enterprises a win?
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Re: Why emerging market bonds?

Post by Northern Flicker » Tue Oct 08, 2019 1:04 pm

Schlabba wrote:
Tue Oct 08, 2019 10:45 am
Thanks for the replies!

Now I am thinking that as long as the EM bonds are counted on the equity side, they provide some useful diversification without sacrificing too much returns.
Is this an answer looking for a question or a question looking for an answer? You sent to be starting with the premise that you need EM bonds, and looking for a reason to justify them.
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Schlabba
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Re: Why emerging market bonds?

Post by Schlabba » Tue Oct 08, 2019 1:33 pm

Northern Flicker wrote:
Tue Oct 08, 2019 1:04 pm
Schlabba wrote:
Tue Oct 08, 2019 10:45 am
Thanks for the replies!

Now I am thinking that as long as the EM bonds are counted on the equity side, they provide some useful diversification without sacrificing too much returns.
Is this an answer looking for a question or a question looking for an answer? You sent to be starting with the premise that you need EM bonds, and looking for a reason to justify them.
I don't need them. I know that I am already investing how I should be investing (as in my signature, MSCI World, MSCI EM + global aggregate bonds hedged to EUR).

I must admit I was a little excited when I found bonds with decent returns. I see my safe bonds as an insurance for the bad times, but I never really liked the idea of losing money on my bonds. I am limiting my safe-bond allocation to a year or maybe 2 years of of cost of living. They are like the emergency buffer of my emergency buffer.
But apart from that fixed amount in bonds I would be 100% allocated to shares. I would be happy to try something there.
IWDA: MSCI World | EMIM: MSCI Emerging Markets | AGGH: Global Aggregate Bond Hedged to €

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Re: Why emerging market bonds?

Post by Northern Flicker » Tue Oct 08, 2019 1:58 pm

You should start with what you are trying to accomplish, them decide on the best way to do that. If EM bonds are part of your equity/risk allocation, then the fact that they have higher yield than treasuries is irrelevant to their evaluation.
Last edited by Northern Flicker on Tue Oct 08, 2019 2:23 pm, edited 2 times in total.
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unclescrooge
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Re: Why emerging market bonds?

Post by unclescrooge » Tue Oct 08, 2019 2:18 pm

Northern Flicker wrote:
Tue Oct 08, 2019 12:53 pm
unclescrooge wrote:
Mon Oct 07, 2019 7:21 pm
PolarInvest wrote:
Mon Oct 07, 2019 3:24 pm
These definitely belong on the equity side, but I think they offer good diversification. For example, they provide equity-like returns, but only declined by about 24% in 2008-09. Obviously they will do worse at other times when US and Int'l Developed stocks do relatively less worse, like in the 1996 currency crisis.

I use them to replace my EM stock allocation, since my belief is that many of the large EM companies in VWO are quasi-state enterprises that can't be valued accurately in any fundamental sense and are subject to political considerations that you'd have to be an insider to quantify accurately. No complaints so far.
why not invest in a fund that excludes state-owned enterprises. Just off the top of my head, i can think of two such ETFs, XSOE and CXSE.
Is being in competition with the state and state-owned enterprises a win?
Probaably not... But it's usually sector specific, and state owned companies are often commodity-driven, capital intensive companies.

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nisiprius
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Re: Why emerging market bonds?

Post by nisiprius » Tue Oct 08, 2019 4:10 pm

A point that is obvious, but should be stated.

Emerging markets bonds don't know or care whether you call them stocks or bonds.

A portfolio of 50% stocks, 30% investment-grade US bonds, and 20% emerging markets bonds will give you exactly the same results regardless of whether you "count" the EM bonds as equities and call it a 70/30 allocation, or whether you "count" them as bonds and call it 50/50.

The only issue here is how you evaluate the risk of your portfolio. If you decide, based on characteristics of normal bonds, that a 50/50 allocation has the right amount of risk for you, and then you go out and replace 20% of your portfolio with emerging markets bonds, then you're kidding yourself because your portfolio is now riskier than a normal 50/50.

If you choose to hold assets that are not really like stocks or like bonds, then you need to find a way to think of your portfolio that is more complicated than stock/bond allocation.
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Re: Why emerging market bonds?

Post by Socrates » Tue Oct 08, 2019 6:56 pm

I have a small allocation to emerging market debt (EMD) in my fixed income allocation for diversification purposes and because it has a slightly higher expected return. Volatility can be high during geopolitical events and other types of global economic crises so probably not for the investor who could not tolerate this in their portfolio.
On a side note.....jazz is cool. Love the screen name and avatar. :sharebeer
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Re: Why emerging market bonds?

Post by Valuethinker » Wed Oct 09, 2019 11:41 am

Schlabba wrote:
Tue Oct 08, 2019 10:45 am
Thanks for the replies!

Now I am thinking that as long as the EM bonds are counted on the equity side, they provide some useful diversification without sacrificing too much returns.
There's a whole question whether they really provide diversification.

It seems to me you are pursuing yield.

There are 2 types of EM bonds. USD bonds (the majority issued by EM) where the pricing probably quite fairly reflects the risk. So in an environment of record low interest rates, not only is the US borrowing more cheaply, but so is Indonesia, say. The borrower is bearing the currency risk, the investor only indirectly so (due to the propensity of countries which devalue, sharply, to also default).

Then there are local bonds. Issued and paying in the local currency. There probably was a serious anomaly here because they were difficult to invest in for foreign investors, and interest was limited.

I suspect the market for locals is no longer inefficient (if it ever was). And in fact it got overinflated as all risk assets have in an environment where safe assets have negative yields. Prospective returns do not compensate for potential losses.

EM bonds do offer a way of gaining exposure to economies with very limited stock markets. For example some Frontier Markets.

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Re: Why emerging market bonds?

Post by JAZZISCOOL » Wed Oct 09, 2019 12:55 pm

Socrates wrote:
Tue Oct 08, 2019 6:56 pm
I have a small allocation to emerging market debt (EMD) in my fixed income allocation for diversification purposes and because it has a slightly higher expected return. Volatility can be high during geopolitical events and other types of global economic crises so probably not for the investor who could not tolerate this in their portfolio.
On a side note.....jazz is cool. Love the screen name and avatar. :sharebeer
Thanks! A little different for the BH site focused on $$$. :thumbsup

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Re: Why emerging market bonds?

Post by hdas » Fri Oct 11, 2019 1:37 pm

nisiprius wrote:
Mon Oct 07, 2019 5:24 pm
They have been high-risk, high return. They haven't been bond-like at all. Some people will always be attracted by high return. I think the view of emerging market bonds is colored by the fact that it is now more than 10 years since this happened, and most emerging market bond funds are less than ten years old... and those that are more than ten years old aren't required to include this time period in the standard descriptive materials, and usually don't.

This is Fidelity's emerging markets bond fund, FNMIX. That's a -40% loss, in a "bond" fund. The recovery was quick, the return since then has been good as you can see by clicking on "source" and picking "max," and some people are convinced this was a one-time event that couldn't possibly recur. But. -40%.

Source

Image
This take is the analogue of showing the drawdown of bonds in the 70's and quickly concluding bonds are not good for your portfolio. Cheers :greedy
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Re: Why emerging market bonds?

Post by bluquark » Sat Oct 12, 2019 1:19 am

I hold about 1/3 of my fixed income (10% of my total portfolio) in local currency EM bonds, in addition to a world market cap equity portfolio holding the usual amount of EM stock. My perspective:

- It appears to have about half the risk and return of equity. The equity risk premium is currently estimated at about 4%, whereas EM bond yield premium over Total Bond is about 2%. The drop in 2008 was also about half the magnitude. It did drop by as much as 40% in 1998 as nisiprius pointed out, but it also yielded much higher in those days. Today you get less juicy yield because the credit ratings on the bonds are higher.

- None of the countries dominant in EM bonds are dominant in EM stock. The two asset classes have nothing to do with each other except for the word "EM". EM stock is an East Asian thing whereas EM bonds has a lot of Latin America and the western end of the Asian continent.

- Since these are governments in parts of the world with very small stock markets, it is an independent source of risk and return from everything else in your portfolio. It will still be correlated with equities during "flight-to-safety" investor herd behavior, but it should drift in different directions in mundane market conditions, and thus provide some diversification premium.

- EM bond funds follow a min/max percent approach. For instance, the VanEck fund has a minimum of 3% in each country and a max of 10%. None of them follow market weight because that would leave them mostly holding bonds from a few very large issuers such as Russia. Thanks to the minimums, they are more spread out among about twenty countries, so any one country's bonds collapsing will only wipe out about a year's worth of yield. The recent trouble in Argentina and Turkey has been bad for EM bonds, but not catastrophic.

- The modern history of EM bonds is good -- the crash in 1998 was more than made up for by long-term holders -- and the longer history of risky sovereign bonds is also reassuring. For example, a little-known fact is that Germany eventually paid off its World War 1 reparations in full.



A tricky decision is whether to use local currency or USD bonds. I have opted for local currency, for the following reasons.

- USD-denominated bonds have lower credit ratings because the governments cannot simply print more. (They can often borrow USD from the IMF so are still safer than corporate junk bonds, though.)

- Local currency EM bonds are a much larger and more liquid market. The market size is $16 trillion. The reason it's so large is that local residents of these countries buy them.

- Expense ratios on local currency bonds ETFs are lower (30 basis points, versus 40). I suspect the costs are also lower in other respects since it's more efficient on the issuer side too to not have to manage USD. By the way, these expense ratios have gotten way cheaper very recently and you'll run into a lot of old advice talking about 1% expense ratios and being excessively negative about the asset class as a result. (Such as the Bogleheads wikipage on them.)

- Countries can inflate away their currencies to reduce their local currency debt. But they really prefer not to because that would blow up their economy. It's a risk, but it's not something they'll casually do, any more than they would casually default.

- In the very long term, local currencies might appreciate against the USD because of PPP effects. In the short term, modeling shows they are fairly valued against the USD.

- 5-year history of local currency bonds underperformed US Treasuries with a lot more volatility, whereas 5-year history of USD EM bonds is a beautiful upward curve. This is because of the recent strengthening of the US dollar. If you opt for local currency bonds, you aren't doing so on the basis of performance-chasing nor the illusion of low-risk yield. I personally find the smooth upward curve of USD EM bonds unnerving and uncanny and there is even a technical term for this: "high skewness and kurtosis". You are loading more of your risk onto crisis events with USD EM bonds, whereas it's more routine with local currency bonds.

- Currency risk is in the eye of the beholder. I expect at least 10% of my retirement spending to be on travel or on imports from other countries, so even though non-USD currencies look more volatile on my brokerage page, in a liability-matching sense they are probably making my portfolio less volatile.

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Re: Why emerging market bonds?

Post by Valuethinker » Sun Oct 13, 2019 6:43 am

hdas wrote:
Fri Oct 11, 2019 1:37 pm
nisiprius wrote:
Mon Oct 07, 2019 5:24 pm
They have been high-risk, high return. They haven't been bond-like at all. Some people will always be attracted by high return. I think the view of emerging market bonds is colored by the fact that it is now more than 10 years since this happened, and most emerging market bond funds are less than ten years old... and those that are more than ten years old aren't required to include this time period in the standard descriptive materials, and usually don't.

This is Fidelity's emerging markets bond fund, FNMIX. That's a -40% loss, in a "bond" fund. The recovery was quick, the return since then has been good as you can see by clicking on "source" and picking "max," and some people are convinced this was a one-time event that couldn't possibly recur. But. -40%.

Source

Image
This take is the analogue of showing the drawdown of bonds in the 70's and quickly concluding bonds are not good for your portfolio. Cheers :greedy
You are reasoning by false analogy, I think.

What nisiprius is trying to show is that EM bonds show behaviour which is quite equity like - extreme volatility during a crisis. He could also have shown you 1994 (Mexico Crash) or 2008 (when EM bonds went down, US Treasuries went up) or indeed 1982 (?) and the Mexico crash then. Or 1929 when what we would now call EM bonds also went into a downward spiral (a number of countries defaulted during the 1930s).

1970s? Bonds were a bad investment. In the years when interest rates were jacked up to 21% (1981-82) bonds did very badly.

But to say bonds have interest rate risk (the latter example) and inflation risk (returns lagged inflation in the late 1960s & 70s) is simply to state that bonds have known risks against those 2 macroeconomic factors. All bonds. Because they are fixed payment instruments (generally).

But what's going on here with EM bonds is a susceptibility to credit risk and to contagion. Although we have had situations like Argentina where the default is very much seen to be an Argentine issue and localised to that country (I think) we have also had situations like 1998 where the rout in EM bonds (& stocks) was general. It did not stop at Thailand nor Indonesia but went on- South Korea, Brasil and finally Russia. Had the liquidation of Long Term Capital Management hedge fund not been orderly, then it could have got a lot worse.

Similarly in 2008 although the debt crisis was a developed market thing, I don't think the bonds of EM countries were, generally, a safe haven.

I would make analogies of US Treasuries vs. High Yield/ junk bonds. The latter have significant equity risk (closely correlated with credit risk) and do poorly at times of financial crisis (the really bad crash in 1990 was partly technical, Michael Milliken's prosecution & the subsequent collapse of Drexel Burnham Lambert; 2008-09 showed just how risky these things are in a general downturn).

So that's nisiprius' message to investors. Do not expect your EM bonds to behave like US Treasuries, or Japanese government bonds, or the stronger countries of the Eurozone bonds, or Swiss government bonds, or even UK gilts. They will show more risk than that and it will probably show up at what are generally bad times in markets.

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Re: Why emerging market bonds?

Post by hdas » Sun Oct 13, 2019 2:55 pm

Valuethinker wrote:
Sun Oct 13, 2019 6:43 am

You are reasoning by false analogy, I think.
This is conceivable but your argumentation fails to prove it.
Valuethinker wrote:
Sun Oct 13, 2019 6:43 am

So that's nisiprius' message to investors. Do not expect your EM bonds to behave like US Treasuries, or Japanese government bonds, or the stronger countries of the Eurozone bonds, or Swiss government bonds, or even UK gilts. They will show more risk than that and it will probably show up at what are generally bad times in markets.
The issues I have with this message:

1. Represents an static view of the world. Emerging market fixed income liquidity, institutions and inner workings are quite different today than 20 years ago. This is not to say that a crisis in the future isn't possible.

2. Its a form of fear mongering, ignoring the benefits of diversification of this asset class and its place in a portfolio. It's part of the general pattern of simplistic rejection of whatever is different from a three fund portfolio approach.

3. It stems mostly for the vacuous association of the word "bond". Why would anybody expect it to behave like US treasuries?....

4. Emerging Market Debt crisis are wonderful opportunities for the patient long term investor.

Cheers :greedy
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

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Re: Why emerging market bonds?

Post by Robert T » Sun Oct 13, 2019 6:24 pm

.
Schlabba wrote:
Mon Oct 07, 2019 1:55 pm
Why are these so popular?

1999-2018: Annualized Return (%) / Standard deviation / 2008 return (%)

9.1 /.. 9.6 / -12.0 = JP Morgan Emerging Market Bond Index (EMBI) Global Diversified
8.8 / 33.5 / -53.2 = MSCI Emerging Markets Index (Stocks)

Correlation between these two indices over this period = 0.76
.

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Re: Why emerging market bonds?

Post by glorat » Sun Oct 13, 2019 11:13 pm

Robert T wrote:
Sun Oct 13, 2019 6:24 pm
.
Schlabba wrote:
Mon Oct 07, 2019 1:55 pm
Why are these so popular?

1999-2018: Annualized Return (%) / Standard deviation / 2008 return (%)

9.1 /.. 9.6 / -12.0 = JP Morgan Emerging Market Bond Index (EMBI) Global Diversified
8.8 / 33.5 / -53.2 = MSCI Emerging Markets Index (Stocks)

Correlation between these two indices over this period = 0.76
.
Since we are now dealing in facts to support whether EM bonds are good diversifier... how does correlation look for Developed World global equities vs Developed World government (or IAAA) bonds?

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Re: Why emerging market bonds?

Post by Schlabba » Mon Oct 14, 2019 1:23 pm

glorat wrote:
Sun Oct 13, 2019 11:13 pm
Robert T wrote:
Sun Oct 13, 2019 6:24 pm
.
Schlabba wrote:
Mon Oct 07, 2019 1:55 pm
Why are these so popular?

1999-2018: Annualized Return (%) / Standard deviation / 2008 return (%)

9.1 /.. 9.6 / -12.0 = JP Morgan Emerging Market Bond Index (EMBI) Global Diversified
8.8 / 33.5 / -53.2 = MSCI Emerging Markets Index (Stocks)

Correlation between these two indices over this period = 0.76
.
Since we are now dealing in facts to support whether EM bonds are good diversifier... how does correlation look for Developed World global equities vs Developed World government (or IAAA) bonds?
Why do you ask? The DM bonds and EM bonds serve a different purpose. Maybe they should be compared to a factor-based approach?
Northern Flicker wrote:
Tue Oct 08, 2019 1:58 pm
You should start with what you are trying to accomplish, them decide on the best way to do that. If EM bonds are part of your equity/risk allocation, then the fact that they have higher yield than treasuries is irrelevant to their evaluation.
I can achieve my goal of building wealth/financial independence without EM Bonds. But could EM Bonds give me a smoother ride? I also considered value funds and small cap funds but they are a lot more volatile without knowing how they will perform in my lifetime. According to the vanguard paper on page 8 EM bonds had a better risk adjusted return between 2002 and 2017.
In any event I would consider it my "play-money" so no more than a 10% allocation.
IWDA: MSCI World | EMIM: MSCI Emerging Markets | AGGH: Global Aggregate Bond Hedged to €

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Re: Why emerging market bonds?

Post by Valuethinker » Wed Oct 16, 2019 2:48 am

[edited - not going to give a reply]

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Re: Why emerging market bonds?

Post by Valuethinker » Wed Oct 16, 2019 2:55 am

Robert T wrote:
Sun Oct 13, 2019 6:24 pm
.
Schlabba wrote:
Mon Oct 07, 2019 1:55 pm
Why are these so popular?

1999-2018: Annualized Return (%) / Standard deviation / 2008 return (%)

9.1 /.. 9.6 / -12.0 = JP Morgan Emerging Market Bond Index (EMBI) Global Diversified
8.8 / 33.5 / -53.2 = MSCI Emerging Markets Index (Stocks)

Correlation between these two indices over this period = 0.76
.
Thank you.

The data period is tricky because it does not include the 1997-98 EM crisis. 1999 is the start of a long bull run in EM bonds.

It also excludes the Mexican near-default of 1994. That was a truly terrifying moment in EM.

China is also a decent chunk of the index? I have not checked PRC's credit rating but I suspect it is above a number of developed countries?

Some EM crises, like Argentina, are due to local factors. Some, like oil price slumps, dramatically affect only a subset of nations (which often have large Sovereign Wealth Funds to stabilise things).

But history says you do get contagion.

The hunt for yield, partly as a result of Quantitative Easing, has taken bond markets into interesting territory. Other than Norinchukin and CLOs (the bank holds 10% of all CLO tranches) it's hard to point at a single weak point.

I remember, though, in 2007, discussing whether there would be a general US housing slump, with someone who had been an economist at one of the major international institutions (he was neutral pointing out the absence of a bubble in Texas). His money was all in commercial property in southern Europe and he was semi-retired.

He dropped off the web very suddenly, and I do wonder what happened to him.

It's getting spooky out there, kind of like the front line knows the Big Push is coming, but not exactly where. Kind of like the spring of 2007 but with no obvious source of malaise (US sub prime car loans, to be sure).

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Re: Why emerging market bonds?

Post by Valuethinker » Wed Oct 16, 2019 3:27 am

In corporate governance terms, EM bonds (borrowed by companies) are preferred to EM equities.

The reason being that debt rights are legally enforceable in most jurisdictions, whereas equity rights, particularly for minority shareholders, are often not, in practice.

Put it another way as a shareholder of Gazprom you do not control its dividend policy or strategy or management to any extent - it's tied straight into the office of the Russian president, and he takes a personal interest.

But they are much more likely to pay interest on its bonds.

There's a whole debate in the Rating Agency world whether a company can have a higher credit rating than the country in which it is HQ'd. I think one of the big 3 (S&P, Moody's, Fitch) says yes, and the other says no?

Comparing EM stocks (private companies) v. EM bonds (issued by governments) is trickier because they are different assets representing claims on different things.

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Re: Why emerging market bonds?

Post by hdas » Fri Oct 18, 2019 10:20 am

Valuethinker wrote:
Wed Oct 16, 2019 3:27 am
In corporate governance terms, EM bonds (borrowed by companies) are preferred to EM equities.

The reason being that debt rights are legally enforceable in most jurisdictions, whereas equity rights, particularly for minority shareholders, are often not, in practice.

Put it another way as a shareholder of Gazprom you do not control its dividend policy or strategy or management to any extent - it's tied straight into the office of the Russian president, and he takes a personal interest.

But they are much more likely to pay interest on its bonds.

There's a whole debate in the Rating Agency world whether a company can have a higher credit rating than the country in which it is HQ'd. I think one of the big 3 (S&P, Moody's, Fitch) says yes, and the other says no?

Comparing EM stocks (private companies) v. EM bonds (issued by governments) is trickier because they are different assets representing claims on different things.
Here's a nice book pertinent to the discussion. Cheers :greedy
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

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Re: Why emerging market bonds?

Post by Valuethinker » Fri Oct 18, 2019 11:52 am

hdas wrote:
Fri Oct 18, 2019 10:20 am
Valuethinker wrote:
Wed Oct 16, 2019 3:27 am
In corporate governance terms, EM bonds (borrowed by companies) are preferred to EM equities.

The reason being that debt rights are legally enforceable in most jurisdictions, whereas equity rights, particularly for minority shareholders, are often not, in practice.

Put it another way as a shareholder of Gazprom you do not control its dividend policy or strategy or management to any extent - it's tied straight into the office of the Russian president, and he takes a personal interest.

But they are much more likely to pay interest on its bonds.

There's a whole debate in the Rating Agency world whether a company can have a higher credit rating than the country in which it is HQ'd. I think one of the big 3 (S&P, Moody's, Fitch) says yes, and the other says no?

Comparing EM stocks (private companies) v. EM bonds (issued by governments) is trickier because they are different assets representing claims on different things.
Here's a nice book pertinent to the discussion. Cheers :greedy
The book seems to be about government default?

I am really focusing on corporate default - a different issue.

"The Chastening" is the definitive narrative of the 1997-98 EM debt crisis, I believe.

https://www.amazon.com/Red-Notice-Finan ... 1476755744 is the best book, perhaps, about the hazards of EM equity investing (Russia, in this case).

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Re: Why emerging market bonds?

Post by Robert T » Sat Oct 19, 2019 2:54 am

Valuethinker wrote:
Wed Oct 16, 2019 2:55 am
The data period is tricky because it does not include the 1997-98 EM crisis. 1999 is the start of a long bull run in EM bonds.

It also excludes the Mexican near-default of 1994. That was a truly terrifying moment in EM.
1994-2018: Annualized Return (%) / Standard deviation / 1994 / 2008 return (%)

8.8 / 12.9 / -19.3 / -12.0 = JP Morgan Emerging Market Bond Index (EMBI) Global Diversified*
5.0 / 31.5 / ..-7.3 / -53.2 = MSCI Emerging Markets Index (Stocks)

Correlation between these two indices over this period = 0.54

* the 1994-1999 EM Bond series used is the EMBI Global Constrained series from the linked article https://faculty.darden.virginia.edu/liw/emf/embi.pdf (similar definition to subsequent Global Diversified series)

1994 returns
EM Bonds = -19.3%
EM Stocks = -7.3%

1994-1998 annualized return

EM Bonds = +7.6%
EM Stocks = -9.3%

PS. Worth noting that EM bond returns were more negatively skewed than EM stock returns (1994-2018)

Another relevant article https://faculty.fuqua.duke.edu/~charvey ... market.pdf
.

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