“Emerging and developing countries are now confronted with a new reality,” IMF Managing Director Christine Lagarde warned central bankers this month, according to Wall Street Journal. “Another bout of global risk aversion could lead to further commodity price declines…and depreciating exchange rates.”
For fixed-income investors, emerging market debt may provide more attractive yield opportunities, but they also come with indirect currency risks and rising credit risks. For instance, the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB), PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY) and Vanguard Emerging Markets Government Bond ETF (NasdaqGM: VWOB) all track USD-denominated emerging market debt. Consequently, a strengthening U.S. dollar or weakening emerging market currencies will make it harder for debt issuers to repay the dollar-denominated debt.
The emerging market bond ETFs include significant exposure to some of the weakest emerging market currencies. Among its top holdings, EMB includes Mexico 6.5%, Russia 5.6%, Brazil 4.0% and South Africa 3.4%. PCY holds Russia 4.0% and other emerging eastern European countries among its top holdings. VWOB includes Mexico 8.3%, Brazil 7.3%, Russia 7.2% and South Africa 1.5%.
Max Chen contributed to this article.