Emerging markets bonds and the corresponding exchange traded funds, including the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) and PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY), are solid performers this year, but with the Federal Reserve seemingly on course to raise interest rates in June, some investors may be concerned about how this asset class will react.
When it comes to U.S. bond ETFs, investors may be attracted to the cheap valuations and wider yield premiums that these bonds offer over safe-haven government bonds after benchmark yields on 10-year Treasuries dipped back toward all-time lows. Moreover, the rebound in energy prices could have reassured investor fears of a potential defaults in the energy space.
Related: 3 Bond ETFs Hinting at Emerging Markets Upside
However, emerging markets bond ETFs, including EMB and PCY, the two largest in the space, offer compelling yields of their. Additionally, these funds look more attractive thanks to the recent struggles encountered by the U.S. dollar.
EMB and PCY provide exposure to U.S. dollar-denominated emerging debt securities, or developing country bonds issued in U.S. dollars. The USD denomination can help support these funds in case of a sudden appreciation in the greenback.
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.
[related_stories]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
Related: The Case for Emerging Markets Bond ETFs
“EM economies have not only survived several severe bouts of financial tightening in the last few years (Taper Tantrum, Dollar surge, commodity price collapse and the start of the Fed hiking cycle), but they have done so with low default rates and improving NIIPs. EM assets today pay high yields and EM currencies are cheap following the giant portfolio shift induced by QE over the last few years. Although the turnaround in favor of EM fixed income has already begun, there is still time to get out of the developed market crash zone,” according to an Ashmore note posted by Dimitra DeFotis of Barron’s.
Iinvestors who typically associated the developing economies with greater risk should note that these emerging bond ETFs include heavy allocations toward investment-grade debt securities. For example, EMB holds investment-grade AA 2.1%, A 12.7% and BBB 42.3%, along with speculative-grade BB 19.2%, B 15.6%, CCC 5.1% and D 3.0%. PCY has AA 6%, A 10%, BBB 37%, BB 24%, B 17% and CCC 3%. VWOB includes Aa 5.9%, A 16.0%, Baa 41.9% and speculative-grade Baa or lower 36.2%.
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iShares J.P. Morgan USD Emerging Markets Bond ETF
