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Understanding Emerging Markets Bond Index EMBI How It s Used

Understanding Emerging Markets Bond Index EMBI How It s Used

Understanding Emerging Markets Bond Index (EMBI) & How It’s Used

What Is the Emerging Markets Bond Index (EMBI)?

The emerging markets bond index (EMBI) is a benchmark for measuring the performance of international government and corporate bonds issued by emerging market countries that meet specific liquidity and structural requirements. Despite their increased riskiness compared to developed markets, emerging market bonds offer portfolio diversity as their returns are not closely correlated to traditional asset classes.

Key Takeaways

  • The EMBI tracks the performance of emerging market bonds and was first published by JP Morgan.
  • Emerging market bonds are debt instruments issued by developing countries, which tend to carry higher yields than government or corporate bonds of developed countries.
  • Most of the EMBI tracks emerging sovereign debt, with the rest in regional corporate bonds.

Understanding the Emerging Markets Bond Index

An emerging market is a developing country or economy that is progressing toward becoming more advanced by industrializing and adopting free-market economies. The largest emerging markets include Nigeria, China, India, Brazil, South Africa, Poland, Mexico, Turkey, Argentina, Russia, etc. Investors look to bonds issued by the government of these nations to take advantage of the rapid growth occurring in these countries.

Emerging market debt or bonds are considered sovereign debt. These government bonds are typically issued in foreign currencies, such as US dollars, euros, or Japanese yen. Due to the increased economic and political risk in these countries, the credit rating on emerging market bonds tends to be lower than that on developed market bonds. In turn, the sovereign bonds have higher yields for investors than more stable bonds in developed countries. For example, the PIMCO Emerging Local Bond Fund delivered a total return of over 14% in the first nine months of 2017, while the iShares Core US Aggregate Bond ETF gained 3.1% during the same time period. Investors who want exposure to emerging economies and are willing to take on additional risk typically do so through mutual funds or exchange-traded funds (ETFs) that track the performance of a benchmark index, such as the EMBI.

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How the EMBI Is Used

Emerging markets bond indexes are used as benchmarks for bond performance in emerging markets. The most popular emerging markets bond indexes are the JP Morgan EMBI+ Index, JP Morgan EMBI Global Index, and JP Morgan EMBI Global Diversified Index. The EMBI+ Index tracks Brady bonds, which are dollar-denominated bonds issued primarily by Latin American countries. The EMBI+ also includes dollar-denominated loans and Eurobonds and expands on J.P. Morgan’s original Emerging Markets Bond Index (EMBI), introduced in 1992 when it covered only Brady bonds. Countries in the EMBI+ index are selected based on a sovereign credit rating level. The index is weighted based on the market capitalization of government bonds, but it is the sub-index with the greatest liquidity requirements, so some markets are excluded. To qualify for index membership, the debt must have a maturity of over one year, have at least a $500 million outstanding face value, and meet stringent trading guidelines to ensure that pricing inefficiencies don’t affect the index.

EMBI+

The JP Morgan EMBI Global Index is an extended version of the EMBI+ Index. The EMBI Global has the same criteria as the EMBI+. However, it does not select countries based on their sovereign credit rating level. Instead, the index includes a number of higher-rated countries through a formula that combines the World Bank-defined per capita income brackets and each country’s debt-restructuring history. Hence, it is somewhat more comprehensive, broader, and, thus, more representative than the EMBI+ Index.

The EMBI Global Diversified limits the weights of countries with larger debt stocks by only including a specified portion of these countries’ eligible current face amounts of debt outstanding. The large markets are weighted lower, and the small markets are weighted higher than in the EMBI Global Index.

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The J.P. Morgan indexes are popular benchmarks for money managers dealing in emerging market debt, allowing investors to compare their mutual funds or exchange-traded funds using the index. Due to their higher interest rates, emerging market bonds can significantly outperform U.S. Treasury bonds. Other emerging bond indexes include Barclays USD Emerging Market GovRIC Cap Index, DB Emerging Market USD Liquid Balanced Index, and Bloomberg USD Emerging Market Sovereign Bond Index.

iShares JPMorgan USD Emerging Markets Bond ETF

Launched with the help of iShares in December 2007, the iShares JPMorgan USD Emerging Markets Bond ETF (EMB) tracks the JPMorgan EMBI Global Core Index. EMBI Global Core is a very broad, U.S.-dollar denominated, emerging-markets debt benchmark. It is also highly diverse – no single debt instrument comprises more than 2% of total holdings, and most fall short of 1%. Nearly three-quarters of the EMBI Global Core is emerging government debt, with most of the rest focused on high-yielding corporate bonds. The expense ratio is in line with expectations for an iShares ETF at 0.40%.

The iShares JPMorgan USD Emerging Markets Bond ETF is best suited for investors looking for a diversified path to high-yielding fixed income. The fund has holdings in 50 countries, including Russia, Mexico, Poland, Hungary, South Africa, and the Philippines.

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