Emerging markets have been under the spotlight so far this year. One of the primary reasons for growing inflows in emerging markets is the uncertainty of President Trump’s protectionist agenda. Investors are worried regarding the implementation of President Trump’s promised tax cuts and de-regulation, after the healthcare bill failure. The increased political tensions in Washington have led many investors to look out for better returns outside the U.S. (read: Can Emerging Market ETFs Retain Their Mojo in 2017?)

Emerging market (EM) bond ETFs provide great diversification potential as their returns are traditionally not highly correlated to other major asset classes in a portfolio. Investors who are looking to offset the currency risk are likely to consider funds issued in U.S. dollars to hedge away the currency risk.

What’s in Favor of Emerging Markets?

Less Hawkish Outlook of the Fed

The Federal Reserve had a relatively dovish stance in its March 2017 meeting. Analysts had priced in three rate hikes this year. However, the Fed indicated a rather slow path toward rate hikes. Moreover, a plan in progress to shrink its $4.5 trillion balance sheet speaks in favor of reduced speed of rate hikes. Therefore, lower rates should push investors towards Emerging markets (read: Dollar Denominated EM Bond ETFs: A Good Play for 2017?).

Rising Commodity Prices

Many emerging markets are commodity centric. Oil prices picked up post the OPEC deal. Even though prices saw a slight downturn due to increased U.S. shale production, these are expected to stabilize with production cuts.

Growth Potential

Emerging markets have shown tremendous potential so far this year. With China’s GDP growing at 6.9% in the first quarter of 2017, a major state election victory for the ruling party in India, and Brazil and Russia emerging out of recession, there is increased confidence that emerging nations will offer higher growth than their developed counterparts.

Downsides

Let us now discuss some of the major risks associated with these investments.

Emerging markets generally have high political risks and poor governance systems. Though the governments of emerging market nations have the backing of global organizations like IMF and the World Bank, this is not the case with corporations based out of these nations. Moreover, liquidity is a concern, as there might be cases when foreign investors are not allowed to convert their earnings back to their home currency for certain period of time.

These sort of issues make ETF investing more practical, as direct investing in these nations might turn out to be costly in terms of due diligence costs. With a high consortium of assets, these issues can be taken care of. The cost is divided and investors do not lose out on an attractive investment area that has the potential to offer increased returns.

Here are a few emerging market bond ETFs that are worth investing in the current scenario. These are denominated in U.S. dollars, thereby hedging away the currency risk associated with these funds.

 iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB - Free Report)

It has AUM of $10.37 billion and charges 60 basis points in fees per year. It bears relatively less concentration risk, as the fund’s top three holdings from a geographical perspective, Mexico, Indonesia, and Turkey, constitute just over 16.5% of the total assets. The fund has weighted average duration of 6.74 years (as of April 13, 2017). It returned 3.53% in the year-to-date time frame and 2.48% in the past one year.

iShares Emerging Markets Corporate Bond ETF (CEMB - Free Report)

It has AUM of $73.32 million and charges 50 basis points in fees per year. The fund’s top three holdings from a geographical perspective, Brazil, Mexico, and China, form a little over 40% of the total assets. The fund has weighted average duration of 5.02 years (as of April 13, 2017). It returned 2.58% in the year-to-date time frame and 1.32% in the past one year.

WisdomTree Emerging Markets Corporate Bond Fund (EMCB - Free Report)

It has AUM of $55.9 million and charges 60 basis points in fees per year. The fund’s top three holdings from a geographical perspective, Brazil, Hong Kong, and China collectively form a little over 41% of the total assets. The fund has Weighted Average duration of 4.97 years (as of April 13, 2017). It returned 3.05% in the year-to-date timeframe and 5.38% in the past one year.

To Conclude

Therefore, we see that the current scenario makes a good case for investing in EM bond funds, as a good diversifier to a portfolio. However, there are significant risks associated with these investments as well. Therefore, it is important to have a close look at them before investing.