Due to their generally higher volatility and exposure to risk, emerging markets bonds should not be expected to provide the “ballast” to investor portfolios that an asset class like U.S. Treasuries can provide. However, they generally exhibit lower correlation to U.S. equities versus U.S. high yield bonds, indicating diversification potential within an investor’s credit portfolio.
Another potential opportunity becomes evident when analyzing the correlations and historical returns of emerging markets corporate bonds compared to emerging markets equities. Over the 10-year period analyzed, emerging markets high yield corporate bonds had greater returns than emerging markets equities, with lower volatility and the benefit of a substantial and steady yield. Due to similar correlation to U.S. equities and global fixed income asset classes, there may be a case for allocating a portion of emerging markets equity exposure into emerging markets high yield bonds.
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The Barbell strategy involves putting half of your portfolio in defensive, low-beta sectors or assets and the other half in aggressive, high-beta sectors or assets. The strategy attempts to get better risk-adjusted returns in the process as well as the worst market periods. For example, by pairing high-yield credit with high-quality government bonds, you can bank on high-quality government bonds to perform well when growth slows down. On the other hand, high-yield assets do well during an economic spurt. The strategy not only limits downside risk but also curtails upside opportunity.
With clouds hovering over where emerging markets (EMB) (EMAG) (IGEM) could go from here, a portfolio constructed with the Barbell strategy could be beneficial. How you choose to balance returns, risk, and downside protection will vary depending on your needs and comfort levels. Just remember that it’s possible to limit portfolio volatility during market turmoil without giving up on your income goals.