This International Bond ETF Could Offer High Yields — and Higher Risk

Key Points

• The Vanguard Emerging Markets Government Bond ETF has proven itself a winner lately.

• The fund has outperformed prominent U.S. and international bond ETFs in the past year.

• But keep in mind that it has 41% of its holdings in bonds with speculative-grade credit ratings.

A big trend right now is investors looking for opportunities beyond the U.S. market. If you want to diversify your portfolio away from U.S. stocks and bonds, one way to do it is to buy an international bond fund, like the Vanguard Total International Bond ETF (NASDAQ: BNDX).

But if you want to earn higher yields and are willing to accept some additional risk, you could buy the Vanguard Emerging Markets Government Bond ETF (NASDAQ: VWOB). This international bond fund lets you own government debt from up-and-coming markets. The VWOB has outperformed the BNDX and another popular bond index fund, the Vanguard Total Bond Market ETF (NASDAQ: BND), for the past year.

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VWOB Total Return Price data by YCharts

Here are a few reasons why you might want to consider the VWOB for your bond portfolio — and why you should also beware of the risks.

What it means to invest in emerging market bonds

When you buy emerging-market bonds, you are investing in debt issued by foreign governments from nations with emerging economies. That includes countries with economies that are more developed than some of the world’s poorer nations, but that have not yet reached the more prosperous levels of advanced economies like the U.S., Japan, Canada, or Western Europe.

Some emerging economies represented in the Vanguard Emerging Markets Government Bond ETF include:

• Saudi Arabia (13.5% of the fund)

• United Arab Emirates (5.6%)

The Vanguard Emerging Markets Government Bond ETF holds 902 bonds and charges an expense ratio of 0.15%. It has delivered average annual returns (by net asset value) of 2.6% for the past five years, 9.99% for the past three years, and 11.6% in the past year.

Image source: Getty Images.

Risks of emerging market bonds

High yields on bonds can be tempting. But emerging markets’ government debt tends to be riskier than advanced economies’ debt. Some of these countries are politically unstable, vulnerable to economic crises, or otherwise might struggle to repay their debts to bond investors like you.

Let’s compare the risk of emerging market government bonds to U.S. bonds. For example, about 41% of the emerging-market bonds in the VWOB have a credit rating of BB or lower, making them speculative grade. But in the Vanguard Total Bond Market ETF, 69% of the fund’s bonds are U.S. government bonds (generally considered some of the safest in the world), while the other 31% of the bonds have investment-grade credit ratings of BBB or higher.

If you want to own emerging market bonds, a lower-risk strategy might be the Vanguard Total International Bond Market ETF (BNDX). This international bond fund holds 6,612 bonds from around the world, with 7.5% of its holdings in emerging markets. The BNDX could give you a more diversified way to capture some of the upside of emerging-market bond yields, while including plenty of bonds from lower-risk markets.

Diversifying your bond investments with international exposure can be a good idea, but try not to take more risk than you can afford. Emerging-market bonds might pay higher yields but could have higher volatility and bigger price declines.

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Ben Gran has positions in Vanguard Charlotte Funds – Vanguard Total International Bond ETF and Vanguard Total Bond Market ETF. The Motley Fool has positions in and recommends Vanguard Total Bond Market ETF. The Motley Fool has a disclosure policy.