ETFs tracking dividend-paying sectors sensitive to interest rates such as utilities and REITs have been hurt by rising Treasury yields and talk the Federal Reserve may soon begin tapering its bond purchases.
Investors can also add emerging market bond ETFs to the list of recent casualties. The sector has been popular and performed well in recent years amid unprecedented stimulus from central banks around the world.
The largest ETFs in this category include iShares JPMorgan USD Emerging Markets Bond Fund (NYSEArca: EMB), PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY), WisdomTree Emerging Markets Local Debt (NYSEArca: ELD), Market Vectors Emerging Markets Local Currency Bond (NYSEArca: EMLC) and SPDR Barclays Capital Emerging Markets Local Bond (NYSEArca: EBND).
The local currency emerging market bond ETFs, such as ELD and EMLC, have fallen harder than the U.S. dollar-denominated funds recently due to the greenback’s strength. [Emerging Market Bond ETFs for Yield]
The pullback in developing market debt ETFs coincides with Fed chief Ben Bernanke saying the central bank was watching for signs of “reaching for yield” and other forms of excessive risk-taking. Bernanke has also hinted the Fed may ease back on its bond purchases if the economic and jobs data improves.
“The most glaring example of bubble-like tendencies is arguably to be found in emerging market bonds, where almost every new offering is met by insatiable demand,” the Financial Times reported last week.
Of course, rock-bottom interest rates have forced income-starved investors to take on more credit risk in search of yield. They have flooded into speculative-grade corporate debt and even substituted dividend-paying stocks in place of bonds.
Risky emerging market bond ETFs with higher yields have also been part of this trend. Yet the voracious demand for developing market debt has triggered bubble fears.
Next page: ‘Rally on steroids’
“The demand is partly driven by genuine and significant improvements in the fundamentals in the developing world. Many countries are now investment grade, and enjoy state finances and economies stronger than many rich countries,” the FT reported.
“But aggressive monetary easing by western central banks has given this rally steroids through programs that both fill the coffers of investors and beat down yields in traditional markets,” the newspaper added. “That has spurred investors to scour the world for higher returns.”
However, emerging market bond ETFs have taken a hit recently as Treasury yields rise and investors speculate the Fed may throttle back on quantitative easing.
After the “emerging market debt bonanza” there are fears investors are set up for a fall, according to a separate FT report on Monday.
“The first is the worry that when central bank intervention eases, there could be a sharp correction,” it said.
“All credit investors are worried about losses when rates start to rise, and bond prices to fall, but this question is particularly pertinent in emerging markets where liquidity is still low in many areas and price swings can be difficult to predict,” the FT noted. “Compounding this is the fact that many of the investors piling into the market are so-called crossover investors, meaning they are not full-time emerging market fund managers but in the market briefly looking for extra yield.”
WisdomTree Emerging Markets Local Debt
Full disclosure: Tom Lydon’s clients own EMB.