Emerging market bonds exchange traded funds have exploded in recent years, attracting billions as investors sought new sources of yield. However, vulnerable currencies and small markets in some developing countries could put pressure on the broader bond funds.
Deutsche Bank singles out Malaysia, South Africa and Indonesia as potentially problematic areas that could put selling pressure on the retail side, reports Shuli Ren for Barron’s.
Large mutual funds can affect the way some emerging market bond markets act. Mutual funds benchmark against the J.P. Morgan GBI-EM GLobal Diversified Index, which caps country weightings at 10%. Consequently, smaller countries have a larger weight in the index. When large emerging market bond funds sell, these smaller markets are typically more sensitive to the foreign capital outflows. [Outflows From Asian Bond Funds Slow a Bit]
Additionally, the South African rand and Indonesian rupiah have depreciated over 20% against the U.S. dollar this year, turning away investors – a weaker foreign currency translates to lower investment gains when converted back into U.S. dollars.
The iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB), which tracks U.S. dollar-denominated emerging market bonds, includes a 5.3% weight toward Indonesia and a 3.9% weight in South Africa. EMB has a 5.07% 30-day SEC yield. [Supply Overhang Could Hamper EM Bond ETFs]
The PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY), which also tracks USD-denominated bonds, has a 5.16% 30-day SEC yield.
The WisdomTree Emerging Markets Local Debt Fund (NYSEArca: ELD) is subject to currency risk as it holds local debt denominated in emerging market currencies. The fund includes exposure to Malaysia 9.8%, Indonesia 6.8% and South Africa 6.6%. ELD comes with a 5.38% 30-day SEC yield.
The Market Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC) also tracks local currency denominated bonds. Country allocations include South Africa 9.6%, Malaysia 8.6% and Indonesia 5.7%. EMLC has a 5.69% 30-day SEC yield.
For more information on bonds, visit our bond ETFs category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.