They always say it is darkest before the dawn. Perhaps the proverbial “they” were referring emerging markets bonds and the exchange traded funds that hold those bonds.
Fueled by the Federal Reserve’s ultra-loose monetary policy that weakened the dollar, yield-starved investors flocked to ETFs such as the iShares JPMorgan USD Emerging Markets Bond ETF (NYSEArca: EMB) and the PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY) last year.
Not only did EMB, PCY and their dollar-denominated and local currency counterparts offer solid yields, these ETFs offered Fed-fueled capital appreciation. The script was flipped when the word “tapering” entered the conversation earlier this year. Tapering might as well be a four-letter word given the havoc it wrought on developing world debt. [Chart of the Day: Emerging Markets Bonds]
However, a new chapter could be starting for emerging markets debt. Sequels to the Asian and Russian financial crises of the late 1990s appear unlikely and many emerging markets are better positioned today to absorb external shocks.
Developing economies have less exposure to dollar-denominated and other hard currency debt today than they did in the 1990s and many are buttressed by strong foreign exchange positions with debt-to-GDP ratios that are impressive, writes Andreas Utermann, co-head and global chief investment officer at Allianz Global Investors, for the Financial Times.
Utermann acknowledges “the case for EM equities is weaker,” but also said weakness in emerging markets bonds could represent buying opportunities “albeit in local currency terms and for long-term investors.”
While the local currency preference could make EMB and PCY less attractive, it is worth noting those ETFs are up an average of 2.7% in the past 90 days. Since the start of October, PCY has seen inflows of $93.3 million. [Cash Returning to Some EM ETFs]
Investors may want to consider the local currency approach again. Utermann expects local currency appreciation to continue in many emerging markets and that could boost ETFs such as the WisdomTree Emerging Markets Local Debt Fund (NYSEArca: ELD), the first actively managed ETF to have over $1 billion in assets under management. All of ELD’s country lineup is rated investment-grade.
In terms of Asia exposure, Malaysia, Indonesia, Thailand, South Korea and the Philippines combine for about 34% of ELD’s weight and of those countries, only Indonesia has a current account deficit.
The $540.3 million WisdomTree Asia Local Debt Fund (NYSEArca: ALD), also actively managed, allocates almost 46% of its weight to those countries, but that ETF is buffered to some degree by a combined 29% weight to AAA-rated Australia, Singapore and Hong Kong. [A Surprising Bond ETF Safe Haven]
The passively managed Market Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC) has just a 5.7% weight to Indonesia with an effective duration of 4.74% years and a 30-day SEC yield of 5.47%.
PowerShares Emerging Markets Sovereign Debt Portfolio
Tom Lydon’s clients own shares of EMB.