With bonds from energy sector issuers making up increasing percentages of high-yield debt indices and exchange traded funds, there has been growing chatter that smaller, cash-strapped U.S. exploration and production companies could set off a raft of junk bond defaults if oil prices continue tumbling.
Bond investors with an eye toward emerging markets may be forced to contemplate the specter of at least one sovereign debt default and how that could affect ETFs such as the iShares Emerging Markets High Yield Bond ETF (NYSEArca: EMHY).
Although not massive allocation by any stretch, EMHY allocates nearly 5% of its weight to Venezuela, a member of the Organization of Petroleum Exporting Countries (OPEC) that is on the brink of a sovereign default.
Two weeks ago, five-year credit swaps used by traders to protect against default on Venezuelan sovereigns traded around 2,300 basis points, but those swaps climbed above 3,100 basis points on Monday, according to Zero Hedge.
That surge in Venezuelan CDS suggests “the same probability default risk as when just after the Lehman collapse, crude traded briefly as low as $30,” according to Zero Hedge.
Venezuela’s impact on EMHY is palpable. The ETF has fallen 4.2% since Oct. 21 when we previously highlighted the fund. On that date, EMHY was allocating close to 11% of its weight to Venezuelan debt, which is to say it is a good thing for the fund’s investors that that number has declined. [One Country EM Bond Investors Need to Monitor]
With oil prices tumbling, Venezuela faces a multiple whammy. The country depends on oil revenue for half of government receipts, a higher percentage than several other major Latin American oil-producing nations. [Oil is a Pain for Frontier ETFs]