Emerging Markets Bond ETFs Look to a Better 2014

Among emerging markets bond exchange traded funds, a once hot corner of the ETF universe, 2013 will go down as a year to forget. That sentiment applies to both dollar-denominated and local currency funds.

Due in large part to fears about the Federal Reserve tapering its asset-buying program, the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB), PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY) and Market Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC) are saddled with an average year-to-date loss of 9.1%.

EMB, the largest emerging markets bond ETF by assets, ranks among the 10 worst ETFs in terms of 2013 outflows with $2.66 billion in lost assets. [Investors Shunning Emerging Markets Bond ETFs]

Although the Federal Reserve previously delayed tapering, some recent U.S. data points that have been positive have some market observers betting a tapering announcement could arrive as soon as this week. Still others believe interest rates could jump above 3% next year, making these rate-sensitive ETFs more vulnerable.

“Over the years as investors have become more comfortable with emerging-markets bonds, issuers have lengthened the average maturity of their issues to 10-20 years. The ETFs in this group have average durations between 7 and 9 years, so if interest rates rise substantially, the long duration of these bonds will likely cause high volatility and negative returns,” according to Morningstar analyst Timothy Strauts.

Investors have some options for staying in the emerging markets bond ETF game without being exposed to long-duration fare. For example, there is the new Market Vectors Emerging Markets Aggregate Bond ETF (NYSEArca: EMAG), which the issuer unveiled last week as a replacement for the Market Vectors LatAm Aggregate Bond ETF.

EMAG which includes the four major categories of emerging markets bonds: 1) U.S. dollar and Euro denominated sovereigns; 2) local currency sovereigns; 3) U.S. dollar and Euro denominated corporates; and, 4) local currency corporates. EMAG has a modified duration of 5.2 years. [Market Vectors Unveils New Global Bond ETF]