Though steadier than their equity-based counterparts, the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) and PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY) are among the exchange traded funds that have been hindered with the slack performances turned by emerging markets this year.
While many emerging markets have garnered a bad reputation for experiencing spiraling debt defaults in face of rapid currency depreciation, the developing economies are more resilient in a weak commodities environment.
According to BlackRock, emerging market governments have accumulated less dollar debt, built up foreign reserves and adopted flexible exchange rates to obviate mistakes during the 1980s and 1990s crises. Though the current outlook for emerging markets debt is far from sanguine, some analysts see opportunity in the asset class. [Investors Turn to Emerging Market Bond ETFs for Higher Yields]
The attractive emerging market bond yields, though, are not without their risks. For example, many fixed-income observers are closely watching the Federal Reserve’s monetary policy. A Fed rate hike could cause a large exit out of emerging market assets in favor of better returns in the U.S.
However, it should be noted that most of the bonds held by EMB and PCY, the two largest emerging markets bond ETFs, are rated well into investment-grade territory. Now, some market observers see opportunity with emerging markets debt.
“Foreign direct investment, portfolio flows, and other flows will be more than sufficient to cover emerging markets’ financing needs over the next 12 months. A positive net-supply of funds to emerging markets should also provide support for currency valuations,” according to a Babson Capital Management note posted by Dimitra DeFotis of Barron’s. “While recent commentary suggests the Fed will likely move to raise rates as soon as December 2015, and U.K. policymakers appear to be on a similar path, monetary policy on a global basis remains extraordinarily accommodative.”
While many may associate emerging markets with greater risks, investors should be comfortable with the relatively improved credit quality of emerging market issuers. According Bank of America Merrill Lynch, over 90% of emerging-markets sovereign debt was rated below investment-grade in 1998, but that number is now less than 40% as of March 2015, Ricardo Adrogué, head of emerging-markets debt, and Brigitte Posch, head of emerging-markets corporates, for Babson Capital Management wrote on InvestmentNews.
iShares J.P. Morgan USD Emerging Markets Bond ETF
Tom Lydon’s clients own shares of EMB.