The quickly appreciating U.S. dollar could increase default risks in emerging market bond exchange traded funds that track USD-denominated securities as countries find it harder to pay back the debt.
For instance, the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) and PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY) both track a portfolio of U.S.-dollar-denominated emerging market bonds. [Mind Your Global ETF’s Currency Exposure]
The market for emerging-market corporate bonds denominated in U.S. dollars has swelled over the years, fueled by income-hungry investors in a low-yield environment, Carolyn Cui reports for the Wall Street Journal.
However, investors may get burned if prices fall off, similarly to what happened late last year on concerns over companies’ ability to service the debt in a strengthening USD environment after more have piled into the USD-denominated emerging market bond funds to capture the rebound this year.
For instance, EMB has attracted $307.3 million in net inflows so far this year, according to ETF.com, while the ETF rose 4.4% year-to-date.
“In countries where we’ll have a significant economic slowdown, an increase of defaults will put strains on the banking sector and potentially trigger a macro event,” Bryan Carter, an emerging-market debt manager at Acadian Asset Management, said in the WSJ article.
For instance, Kaisa Group Holdings, a major real estate company, defaulted on its U.S.-currency debt, raising concern that defaults will spread, Bloomberg reports. China makes up 4.1% of EMB’s underlying holdings.