Emerging Market Bond Index (EMBI)

It is an index used as a benchmark to measure national and corporate bonds' overall performance. 

EMBI stands for Emerging Markets Bond Index. It is an index used to measure national and corporate bonds' overall performance. 

Emerging Market Bond Index (EMBI)

These bonds are issued in nations with emerging markets with particular requirements in structure and solvency. 

Emerging market bonds are often considered solid investments because they allow one to diversify their portfolio properly. In addition, it is partly because such bonds are not correlated to standard asset classes. 

On the other hand, there is a high risk associated with such financial instruments since the related governments are still underdeveloped. 

Emerging markets are economies in a developing phase that are working on new technologies and industries, moving towards a more advanced economy. Hence, individual and external institutions invest in emerging market bonds to exploit the growth of such countries. 

Emerging market bond exchange-traded funds exist thanks to developing economies issuing sovereign debt.

These financial products have significantly low credit quality, making them less trustworthy. However, they provide higher returns than regular bonds issued by developed countries.

The pool of emerging markets includes:

Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Russia, Saudi Arabia, South Africa, Taiwan, Thailand, Turkey, and the United Arab Emirates.

How does it work? 

Emerging market bonds are a way for emerging countries to finance their projects. They usually issue sovereign debt in foreign currencies (euros, US dollars, or Japanese yen). 

Function

The credit ratings of these emerging countries' bonds are significantly lower than those of mature countries' bonds. It is due to the high political risk of such countries. 

These low credit ratings lead to sovereign bonds offering significantly higher returns for investors than bonds of already-developed countries. 

Investors usually decide to go for mutual funds or exchange-traded funds that follow the performance of certain indexes (e.g., the Emerging Markets Bond Index). They do so because they are willing to increase their portfolio risk and want to bet on the development of such countries. 

Emerging markets bond indices serve as standards for bond performances in developing countries. The following are some of the more popular developing nation bond indices: 

1. JP Morgan EMBI+ Index 
The EMBI+ Index is formed of dollar-based bonds issued mainly in Latin American countries, the so-called Brady bonds. 

Dollar

This index is also composed of Eurobonds and dollar-based securities, increasing the financial products initially present in JP Morgan's EMBI, which only had Latin American bonds. 

Governments that are in EMBI+ are chosen upon sovereign credit levels. In addition, this index is weighted based on the government bond's market capitalization

For financial instruments to be eligible for the EMBI+, the sovereign debt must have a maturity longer than a year, meet predetermined trading recommendations that guarantee no pricing-related issues, and have a minimum face value of $500 million. 

It measures the total value of debt exchanged in emerging countries. It helps investors with crucial insights regarding emerging markets (types of instruments exchanged, terms, and debt insights).

2. JP Morgan EMBI Global Index
The JP Morgan EMBI Global Index can be considered a complete version of the EMBI+. It is in charge of computing the total return of foreign emerging-market bonds that are exchanged. However, it has a different method for choosing countries. 

Gold Coins

The EMBI Global incorporates several countries considered higher-rated, computed with the per capita income defined by the World Bank and the government's debt composition records. This makes it a broader and more illustrative representation than the EMBI+. 

It differs from the EMBI+ because it includes financial instruments such as loans, Brady Bonds, and Eurobonds. 

These bonds must also meet the $500 million face value requirements, like the EMBI+. However, no specific rules involve trading liquidity in secondary markets.

Usually, larger governments make up a minor portion, with the smaller markets making up the rest of the EMBI Global Index.  

3. JP Morgan EMBI Global Diversified Index
The EMBI Global Diversified offsets the influence of governments with significant debts by having only a particular stake in these governments' outstanding debt.

The EMBI Global Diversified limits the weights of countries with more extensive debt stocks by only including a specified portion of these countries' eligible current amounts of debt outstanding.

The large markets are weighted lower, while the smaller markets are weighted higher than in the EMBI Global Index.

These indices created by JP Morgan have become a famous benchmark for emerging market debt. In addition, they help investors compare the emerging bond market with mutual funds or exchange-traded funds (ETFs). 

Building

It is very likely for emerging market bonds to outperform US Treasury Bills, thanks to their higher interest rates. 

Other popular emerging bond indices are listed below: 

  • iShares Emerging Markets High Yield Bond ETF
  • WisdomTree Emerging Markets Local Debt Fund
  • First Trust Emerging Markets Local Currency Bond ETF
  • SPDR Barclays Capital Emerging Markets Local Bond ETF
  • Invesco Emerging Markets Sovereign Debt ETF
  • SPDR DoubleLine Emerging Markets Fixed Income ETF
  • Vanguard Emerging Markets Government Bond ETF
  • iShares Emerging Markets Local Currency Bond ETF

Pros and Cons

EMB ETFs invest in the debt of emerging market economies. Such ETFs have lower credit quality than those invested in bonds from advanced economies. However, they tend to provide higher returns.

Work

Investing in these financial products has several positive, as well as risky, aspects. 

Risks can be placed into three categories: 

  1. Politics: The political composition of emerging governments can often be unsafe. This can lead to significant issues, increasing the chance of investors not receiving their funds.
  2. Economy: The economic status of an emerging market is very different from a developed one. It is possible to see these differences through macroeconomic indicators such as employment or inflation.
  3. Local Currency: Currencies of emerging countries are known to be particularly volatile because of conversion rates. This means that eventual profits can be lowered in unfavorable conversion rates. 

On the other hand, there are two main pros related to EMBI: 

  1. Portfolio Diversification: Investors can achieve portfolio diversification when buying such bonds. 
  2. Growth & Development: Such countries' potential growth and development is a great advantage. With the power, they acquire in the global market through bonds, the likelihood of repayment may increase.
Key Takeaways
  • The Emerging Markets Bond Index is used to measure national and corporate bonds' overall performance.
  • These bonds are issued by nations with emerging markets, assuming they fulfill particular requirements for structure and solvency.
  • Because they are not correlated to regular asset classes, they are considered solid investments for portfolio diversification. 
  • Emerging markets are economies in a developing phase, working on new technologies and industries. 
  • These bonds finance projects in emerging countries. These nations issue sovereign debt in popular foreign currencies (US dollars, euros, yen, etc.).
  • The high political risk of these countries makes their credit rating lower than that of more advanced economies. 
  • The EMBI Index consists of Brandy bonds, dollar-based bonds issued in Latin American countries.
  • Governments in the index EMBI+ are chosen based on their sovereign credit. 
  • In the EMBI Global Index, bigger governments make up a minor portion, while smaller ones have a more significant impact.
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Researched and authored by Alessandro Davì | LinkedIn

Reviewed and edited by James Fazeli-Sinaki | LinkedIn

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