Exchange traded funds holding emerging markets debt were among the asset classes believed to be potentially vulnerable Donald Trump’s presidency.
After tumbling immediately following Election Day, the dollar-denominated funds such as the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) to local currency fare such as the Market Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC) have been steady performers this year.
However, investors should continue taking a tactical approach to developing world debt, according to some market observers.
The PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY), another dollar-denominated ETF, is another emerging markets bond ETF to consider.
“The yield premium demanded by investors on developing-nation notes over U.S. Treasuries is likely to narrow amid an improvement in global growth prospects and risk sentiment, Goldman analysts Andrew Matheny and Sara Grut said in a note Monday. But the influential Wall Street firm — which counts several alumni among Trump’s administration — favors investment-grade bonds from Central & Eastern Europe, the Middle East and Africa,” reports Lilian Karunungan for Bloomberg.
It could be a good idea for investors to avoid debt issued by countries that Trump has mentioned in negative fashion. That would include Mexico and some other Latin American economies that could suffer if the new president is able to push through protectionist trade policies.
If the Federal Reserve hikes rates, emerging market companies that borrowed overseas are more susceptible to foreign capital swings and could find it more difficult to refinance debt. Moreover, a strengthening dollar makes it costlier to pay off dollar-denominated bonds.
PCY, which has a 30-day SEC yield of just under 5.3% and a modified duration of 8.5 years, features some exposure to Central European and African economies, regions highlighted by Goldman Sachs. Those regions combine for over 10% of the ETF’s top 10 holdings.
“Goldman is shifting its preference to investment-grade debt from high yielders because economies with lower leverage and more local-currency denominated liabilities are likely to be less impacted by strength in the dollar, Matheny and Grut said,” according to Bloomberg.
EMLC, which holds bonds denominated in local currencies, allocates about 23% of currency weight to bonds from Central and Eastern European issuers. Poland is that ETF’s largest country weight, followed by Mexico.
For more information on the fixed-income market, visit our bond ETFs category.