Emerging Market Bond ETFs that Hedge Currency Risks
May 25th 2012 at 9:00am by Tom Lydon
Emerging market equities and bonds have become standard in investors portfolios, as stronger economic growth in these countries is evident. Emerging market government issued bond exchange traded funds (ETFs) have increased in popularity due to their high yield and diversification benefits.
“With the sovereign debt crisis in Europe, investors are re-evaluating which countries are most creditworthy. The developed world has good credit ratings and very high debt levels. The emerging world has below-investment-grade ratings and low debt levels. There is growing belief that despite emerging markets’ lower credit ratings they may actually be better credit risks,” Timothy Strauts wrote in a Morningstar fund analysis.
The latest ETFs offer emerging market yields without the currency risk that is associated with overseas investing. Many emerging market governments and businesses issue debt securities denominated in U.S. dollars to attract international interest, reports ETF Base. [The Case for Emerging Market Bond ETFs]
Emerging market bond ETFs are riskier than U.S. government debt, however, the payoff comes in the form of higher yields. Many emerging market bond ETFs have yields around 5% or higher, compared to the 20-year US Treasury, for example, which yields only 2.4% while the 10-year provides only 1.71% annually. [Best ETFs for Dividend and Income]
Furthermore, emerging market debt ETFs usually holds bonds rated under A which allows for plenty of upside should the bond receive a higher rating. As funds are rebalanced to the index, profits can be reinvested in other bonds on the verge of credit improvement for a very powerful compounding effect, reports ETF Base.
Overall, emerging market debt priced in U.S. dollars is more liquid, which can keep uncertainty in foreign debt issues lower than that of debt issues denominated in local currencies. [Bond ETF Ideas for Higher Yields]
Two high-yield emerging market debt ETFs:
- JP Morgan Emerging Markets Bond Fund (NYSEArca: EMB) yields 4.75%
- PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY) yields 5.27%
Tisha Guerrero contributed to this article.
Full disclosure: Tom Lydon’s clients own EMB.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.