Vanguard Case for Emerging Markets Bonds as Cuts Near

Vanguard portfolio manager Daniel Shaykevich says falling U.S. rates boost emerging markets bonds.

As the Federal Reserve is likely to cut interest rates at its two-day Federal Open Market Committee meeting this week, a top Vanguard portfolio manager sees value in select emerging-market bonds.

When U.S. Treasury rates fall, emerging-market bonds benefit. These bonds are usually longer duration because sovereign nations often borrow over the long-term, says Daniel Shaykevich portfolio manager and co-head of the emerging markets and sovereign debt team in Vanguard’s Fixed Income Group.  

These bonds often have a higher spread over U.S. Treasuries as well, and the combination of duration and spread creates stronger risk-adjusted returns over the long run, despite the asset class’s weakness over the past few years, he says.

They’re also more attractive that U.S. high yield bonds at the moment as well, he says, both on a relative value basis and where the U.S. economy is in its business cycle.

Vanguard’s active bond fund, Vanguard Core-Plus Bond ETF (VPLS), which Shaykevich co-manages, shows that preference. The fund has a 12% weight to emerging markets, at the higher end of the 5% to 20% range it can have. VPLS’s high-yield holdings are at the fund’s low end, which ranges between 5% and 25%.

Emerging Markets Bonds and Rate Cuts

The fund isn’t at its maximum risk levels for emerging markets, he says, “but just because you don't have a big beta trade on doesn't mean you don't have relative value opportunities, both from the bottom up, by selecting the right names, and also on a sector level.”

Shaykevich is mindful of the potential of a global economic slowdown caused by elevated interest rates, so they’re selecting middle-credit quality issuers. “We’re not buying as much of the riskiest frontier paper … It's just not the right time of the cycle to be doing that. But we do have a strong allocation to EM,” he says.

Shaykevich has managed emerging markets for the past 12 years at Vanguard and before that at Blackrock, and says the field has broadened beyond the classic “BRIC” countries of Brazil, Russia, India and China, with more countries issuing debt and across the credit spectrum. On average, credit quality averages between U.S. investment grade and U.S. high yield.

Even as more countries are issuing debt, pure emerging-market funds still tend to be concentrated.

“I always caution people when they invest in EM is just be careful, because this is an asset class that's a little bit more concentrated. It's not unusual for an EM fund to have 5% or even 10% exposure to a single country,” he says.