Emerging Market Bonds Say “Buy Me”

Eric Fry By Eric Fry, Macro Strategist, The Oxford Club

Bond Investing

Editor’s Note: The publisher of Wealthy Retirement, The Oxford Club, recently welcomed a new guru to its ranks… Macro Strategist Eric Fry.

Eric is an international finance expert and former hedge fund manager with 30 years of investment experience. He’s worked in Europe for one of the biggest brokerages in the world… ran a successful money management firm… and even led his own boutique research firm at one of the most coveted addresses on Wall Street.

Most recently, he’s received a lot of press for his performance in the Portfolios with Purpose competition.

The project brings together the brightest minds in finance to invest on behalf of their favorite charities. Last year, Eric’s portfolio beat nearly 650 other professional investors… with an average return of 150%.

That means he outperformed the broader market by 593.5%.

For today’s issue, we asked him to share a unique bond investing strategy. We’re confident you’ll find his outside-the-box commentary extremely valuable.

– Rachel Gearhart, Managing Editor

Risk, like beauty, is often in the eye of the beholder. For example, most folks consider U.S. Treasury bonds to be low-risk assets. But in the eyes of some beholders, like me, today’s low-yielding Treasurys are high-risk assets.

Because most Treasury securities now yield close to nothing, they offer what a good friend of mine calls “return-free risk.” If things go well with this investment, you’ll make a tiny bit of money. If things go slightly less well, you’ll lose a lot of money.

That’s a high-risk proposition.

Emerging market bonds are also high-risk. But at least they offer the promise of a high reward to go along with that risk. Not only do they pay high interest rates, but they also provide an opportunity to profit from a falling dollar.

So it’s easy to make the case that a diversified portfolio of emerging market bonds has become a much more alluring risk than a portfolio of Treasurys. Consequently, it’s easy to make the case that investors should be selling Treasurys and buying emerging market bonds.

Let’s take a look at the trends that have created this particular investment opportunity.

Ever since the 2008 crisis, the Federal Reserve has been trying to stimulate economic growth by manipulating interest rates lower. To conduct this manipulation, the Fed has purchased trillions of dollars’ worth of Treasurys in the open market – a process that became known as “quantitative easing.”

The Fed’s bond-buying campaign pushed interest rates even lower.

(Remember, price and yield move in opposite directions. So when bond prices rise, yields fall.)

As interest rates fell, ordinary investors rushed in to buy Treasurys… before rates fell even lower. This multiyear buying frenzy pushed down rates on 30-year Treasurys from 4.70% at the end of 2009 to a low last year of 2.10%.

Thanks to this big bull market, long-dated Treasurys have been producing huge equity-like returns during the last several years. For perspective, an investor who purchased the iShares 20+ Year Treasury Bond ETF (Nasdaq: TLT) near the beginning of 2011 would have received a total return of nearly 90% – beating the 80% return the S&P 500 Index delivered over the same time frame.

But interestingly, emerging market bonds have not been rallying alongside Treasurys; they’ve been doing the opposite.

They’ve been falling… a lot. The chart below tells the tale.

The iShares ETF share price has been churning higher during the last six years, while the price of the VanEck Vectors J.P. Morgan Emerging Market Local Currency Bond ETF (NYSE: EMLC) has been drifting lower.

The soaring U.S. dollar caused most of the damage to the value of the VanEck Vectors ETF. That’s because this ETF holds emerging market bonds that are denominated in the local currencies of each issuing country. So when the U.S. dollar goes up in value, these various foreign currencies go down in value. Therefore, the U.S. dollar value of the bonds in the VanEck Vectors ETF portfolio goes down.

You can see that inverse relationship very clearly in the chart below.

You can also see that the dollar has been weakening somewhat during the last few months, which has boosted the performance of the VanEck Vectors ETF. The ETF is up more than 10% since the Dollar Index started to slide from its record high late last year. If the dollar’s recent weakening trend continues, the VanEck Vectors ETF could continue to deliver very large gains.

But the likelihood of dollar weakness is just one part of the VanEck Vectors ETF’s investment appeal. The other part is the high rate of interest its bond portfolio pays.

This ETF holds about $2 billion worth of emerging market government debt from countries like Poland, Mexico, Brazil and Indonesia. Thanks to these high-yielding securities, the VanEck Vectors ETF pays an annual dividend yield of 4.94%.

So let’s put that yield in our back pocket for a moment and consider a couple of possible scenarios:

  1. If, over the next 12 months, the U.S. dollar slumped to its year-end 2014 level, the VanEck Vectors ETF would deliver a total return of roughly 13%.
  2. If, over the next 24 months, the U.S. slumped to its year-end 2013 level, the VanEck Vectors ETF would deliver a total return of roughly 32%.

The dollar may not continue weakening, of course. But then again, nothing is risk-free… not even U.S. Treasurys. To put that risk in perspective, let’s consider one very plausible scenario:

  1. If, over the next 12 months, the yield on the U.S. 30-year Treasury rose from its current yield of 2.91% to its year-end 2013 level of 3.96%, the price of the iShares 20+ Year Treasury Bond ETF would drop by about 20%. That result might not be disastrous, but it wouldn’t be particularly appealing either – especially not from a “low-risk” security.

My advice? Sell low-risk Treasury ETFs like the iShares Bond ETF; buy high-risk emerging market bond ETFs like the VanEck Vectors ETF.

Good investing,


P.S. Please join me on Wednesday, June 7, for a free live event in which I discuss more opportunities just like this one. In fact, I’ll reveal how you can beat the market 10 times over using my unique macro investing strategy. To receive your invitation, click here now.