EM Bond ETFs Face Another Russia Downgrade

Despite another tumultuous year for emerging markets equities, investors have remained confident regarding sovereign debt issued by developing world governments.

Last week, the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) and the PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY) took in almost $74 million combined, bringing year-to-date inflows to those ETFs to $1.1 billion and $377.5 million, respectively.

There have been some pitfalls along the way for emerging markets bond funds, including elections, geopolitical tensions and credit downgrades. Those ETFs with hefty exposure to Russia will have to contend with another downgrade to that country’s sovereign rating. Last Friday, Moody’s Investor’s Service pared its rating on Russian government debt to Baa2 from Baa1, the ratings agencies second-lowest investment grade.

EMB and PCY, the two largest emerging markets bond ETFs, have relatively light Russia allocations. Actually, PCY, the PowerShares offering, features no Russia exposure. EMB devotes just 5.4% to Russian bonds. [Diversify With EM Bond ETFs]

However, other emerging markets bond ETFs do have larger weights to Russia. There are some positives here. For example, these ETFs have been down this road before with Russia. In April, Standard & Poor’s lowered its rating on Russian sovereign debt to BBB-, the lowest investment grade. [Russia ETFs Fall After S&P Downgrade]

The ProShares Short Term USD Emerging Market Bond ETF (BATS: EMSH) featured combined allocation of nearly 19% to Russian and Ukrainian debt when S&P downgraded Russia in April. The ETF currently devotes 9.7% to Russian bonds, its largest country weight by 140 basis points over Indonesia.