Choose emerging market corporates

This story originally appeared on benefitscanada.com.

Last month, Newport Beach, Calif.-based PIMCO gave a shout-out to emerging market corporate bonds in this note, calling them an ideal alternative to the crowded emerging market sovereign space and yet another reason for investors to turn away from those sad-sack sovereigns developed markets have been churning out in recent years.

Indeed, if you believe experts quoted in this Financial Times article, the impact of financial repression on sovereign bond markets in the U.S. and Europe will prove disastrous to pension funds as they come under increased pressure to buy them in large quantities in spite of next-to-nothing real returns.

Read: Emerging outpacing developed markets

Pension funds and other institutional investors have been going further afield in the hunt for yield, moving further into emerging market debt, mainly on the sovereign side. Most recently, Norway’s US$660-billion sovereign wealth fund made headlines when it announced it’s reducing its exposure to French and Spanish government notes and boosting its emerging market debt.

This move makes Mexico Norway’s 10th largest bond investment. In the past year alone, the sovereign wealth fund has raised its holdings of emerging market currency bonds to 8% of its total fixed income holds (up from just 1.5% at the end of last year).

Read: Why emerging markets matter

The problem is, emerging market sovereign debt is getting harder to find as the market becomes more crowded. According to PIMCO, the supply of U.S. dollar-denominated emerging market sovereign debt is decreasing, and yields are headed down to historical lows.

So where does that leave a yield-hungry investor? The U.S. dollar-denominated emerging market corporate bond space has doubled in size since 2008 and now stands at nearly $1 trillion, much larger than the sovereign market, which say the authors of the PIMCO note, Ignacio Sosa, Anton Dombrovsky, stands at just $680 billion. With higher yields and shorter durations, they also offer some protection against rising interest rates.

Read: The new threat to emerging markets

The performance of a growing number of emerging market corporate debt ETFs seem to affirm PIMCO’s story, including the iShares iBoxx $ Investment Grade Corporate Bond Fund, with a 30-day SEC yield of 2.74% and an effective duration of 7.84 years.

There’s also the WisdomTree Emerging Markets Corporate Bond Fund, with a 30-day SEC yield of 3.69% and an effective duration of 6.23 years. Not bad performance. In fact, more and more, ETFs seem like a good way to access the emerging market space, especially as the depth and breadth of the market increases. On the corporate bond side, they could provide an easy and liquid way to step into the space.