HYEM ETF: Question and Answer

High yield (HY) emerging markets (EM) corporate bonds are a compelling investment opportunity that is often overlooked in a broader strategic asset allocation. In this Q&A, we explore the size, composition and advantages of the EM high yield corporate bond market. We also provide insights into the risk profile of the asset class, performance drivers, and accessing exposure with the VanEck Emerging Markets High Yield Bond ETF (HYEM).

• What is the size and composition of the high yield EM corporate bond market?
• Why invest in high yield EM corporates?
• What is the credit quality profile of EM high yield corporates?
• What are the major risk/performance drivers of high yield EM corporate bonds?
• How do high yield EM corporates fit within a portfolio?
• How can investors access high yield emerging markets corporate bonds?

What is the size and composition of the high yield EM corporate bond market?

The global high yield space has a market value of approximately $1.4 trillion, of which emerging markets issuers make up about 17%. The ICE BofA Diversified High Yield US Emerging Markets Corporate Plus Index tracks EM HY corporate bonds issued by companies across 48 countries and 20 sectors. Sector exposures within the EM HY corporate bond universe are shown below.

High Yield EM Breakdown by Sector

Adding EM high yield corporate bond exposure can therefore allow investors to generate higher yields without taking on additional credit risk compared to a more U.S. focused high yield allocation.

What is the credit quality profile of EM high yield corporates?

The overall credit quality of the bonds held in the HY EM corporate bond index is higher than that of U.S. HY bonds (as represented by the ICE BofA U.S. High Yield Index), with a higher weighting to BB rated bonds and a lower weighting to single B and below rated bonds. EM high yield corporate bonds have historically exhibited a similar annual average default rate versus U.S. HY corporate bonds (note: the relatively high default rate in 2022 was primarily due to Russian issuers and companies in the Chinese property sector).

Emerging Markets HY Bonds Tilt to Higher Quality

What are the major risk/performance drivers of high yield EM corporate bonds?

High yields (due to significant credit spreads, i.e., the differential between HY EM bonds and risk-free benchmarks such as U.S. treasuries) are the primary return contributor for HY EM corporate bonds. Investors benefit from the high level of interest that can be earned by holding these bonds. However, movements in spreads can introduce price volatility. Although investors benefit from a decline in credit spreads, which may reflect lower perceived risk implied by market pricing, bond prices will decline if spreads widen. In periods of stress, high yield credit spreads can widen significantly.

In addition to credit spreads, the direction of U.S. interest rates will also impact returns because the bonds are denominated in U.S. dollars. A decline in interest rates results in higher bond prices, increasing total returns, while an increase in U.S. interest rates will detract from total return. Investing in EM corporates also involves unique risk drivers, such as political instability in emerging markets, which can lead to changes in economic policies and regulatory environments that impact corporate profits. HY EM corporate issuers may also have currency risk, as fluctuations in their local currency against the U.S. dollar can affect their ability to repay debt. Additionally, EM corporates often operate in less mature and less transparent markets, which can increase both credit and liquidity risks.

How do high yield EM corporates fit within a portfolio?

An allocation to high yield EM corporates can allow investors to build a higher-yielding, more complete global high yield portfolio that provides exposure to emerging markets growth opportunities. High yield emerging markets corporate bonds are not represented in U.S. high yield bond benchmarks, which creates significant diversification potential. Second, HY EM corporates allow investors to capitalize on the growth potential within EM, as many of these countries have shown higher growth rates than developed markets. EM corporates that derive most of their revenue in these higher growth countries may potentially benefit from higher corporate earnings and improved fundamentals. Moreover, HY EM corporates can serve as a complement to EM equities, offering potentially lower volatility and a different risk-return profile. Alongside an EM equity allocation, EM corporate bond exposure can allow investors to capture EM growth opportunities, while generating attractive income and lowering the volatility of an overall EM allocation.