Fixed income investors have heard plenty in recent months about the impact higher U.S. interest rates will have on corporate bonds and the corresponding exchange traded funds. There has also been plenty of news regarding the effects of higher U.S. borrowing on emerging markets sovereign debt funds.
However, after some significant declines earlier this year, the time could be right for investors to consider emerging markets corporate bond ETFs, such as the iShares Emerging Markets Corporate Bond ETF (NYSEArca: CEMB).
In the years after the 2008 financial crisis, emerging market corporations issued trillions of dollars of foreign-currency bonds, taking advantage of the low interest rates in developed countries, the Wall Street Journal reports.
Now, emerging market currencies are experiencing a steep depreciation and a plunge in commodity prices have fueled redemptions from emerging markets, adding to fears that emerging companies may not be able to repay their USD-denominated obligations, especially as the Federal Reserve looks to hike interest rates ahead.
“High-yield corporates underperformed significantly, down 3.2% in the past month, clearly affected by the weakness in U.S. high yield. Equivalent high-yield sovereigns were down only 0.9%. By region, Latin America was the main driver. By sector, it was again mining and metals that underperformed, with total returns down 6.4% in the past month. … Russian corporate spreads were also affected this time around, although largely driven by the sovereign spreads widening,” according to a Morgan Stanley note posted by Dimitra DeFotis of Barron’s.
Earlier this year, the International Monetary Fund recently issued a warning on corporate debt of nonfinancial firms across the emerging economies as the highly leveraged firms have quadrupled their debt load over the past 10 years to $18 trillion as of the end of 2014. Emerging market corporate debt to gross domestic product increased 26 percentage points in the past decade to 74%.
Controversial spots are concentrated in some markets, such as Brazil where spreads between yields of Brazilian corporate debt and U.S. Treasuries have widened to nine percentage points as foreign investors exited the market amid signs of rising political and economic problems.
“What’s rich or cheap? Most country and sectors are now shown as cheap again following the recent widening. Real estate and transport are the only sectors which trade rich on a 6m basis. Russian corporates are now only shown as slightly rich,” adds Morgan Stanley in the note posted by Barron’s.
iShares Emerging Markets Corporate Bond ETF
