It’s Not All Bad in Emerging Market Debt ETFs

January 29th at 8:15am by Todd Shriber

For as bad as equity-based emerging markets exchange traded funds have been this year, and they have been rather dismal, their bond counterparts have at least been significantly less bad. In some cases, emerging markets bond ETFs have even been decent.

Still, some ETFs that hold developing world sovereign debt feature exposure to controversy-riddled nations  such as Turkey, Ukraine and Venezuela, enough to draw scorn from investors. Last week, the Turkish lira fell to a record low against the U.S. dollar and at the end of last year, foreign investors were seen disposing of Turkish sovereign debt at the most rapid pace in two years.  Also last week, the yield on Venezuelan bond’s jumped to 14.5% with the South American country’s benchmark bonds hitting two-year lows. [Tough Times for This Bond ETF]

“Emerging markets are suffering from a variety of afflictions at the moment,” said Market Vectors Portfolio Manager Fran Rodilosso. “The concern remains that Fed tapering may pull more investment dollars away from both emerging markets debt and equity. This has been compounded by negative news and/or economic data from Turkey, South Africa, Argentina, Ukraine, and, most importantly, China.”

With political stress high in some emerging markets, think Turkey and Ukraine, and rising account deficits eroding investors’ confidence in the likes of Brazil and South Africa, there has been talk of an emerging markets crisis on par with the Asian sovereign debt crisis of the late 1990s.

Rodilosso notes there are examples of some developing markets being more mature today than during prior crises and that the longer-term trend of increased institutional allocations to developing world debt remains intact.

This year’s price action in emerging markets bonds ETFs would confirms Rodilosso’s assertions. Dollar-denominated funds, such as the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) and the PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY) are flat on the year. Although the Market Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC) is off more than 3%, that is a far cry from the 8% loss sported by some diversified emerging markets equity ETFs. [Risks Abound in Indonesia]

Rodilosso also noted that the yield spread on emerging markets junk bonds relative to equivalent U.S. issues surged to 200 basis points by the end of last year after starting the year at a spread of just 25 basis points.

Investors can grab the Market Vectors Emerging Markets High Yield Bond ETF (NYSEArca: HYEM), which has a comparable duration and 2014 performance to the largest U.S. junk bond ETF, with a 30-day SEC yield north of 7%. China, Russia and Mexico combine for 37% of HYEM’s weight.

Market Vectors Emerging Markets High Yield Bond ETF

Tom Lydon’s clients own shares of EMB.